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CAMBRIDGE ECONOMIC HANDBOOKS.— I 

^ GENERAL EDITOB: J. M, KETNES, M.A., CB. 



SUPPLY AND DEMAND 



SUPPLY AND 
DEMAND 



HUBERT D. HENDERSON 

M.i. 

FELLOW OF CLAKE COLLEGE, CAMBRIDGE 
LECTT7BEB IN ECONOMICS IN THE UNIVERSITY OF CAMBRIDGE 



WITH AN INTRODUCTION BY 

J. M. KEYNES 

M.A., C.B. 
FELLOW OF king's COLLEGE, CAMBRIDGE 



m 




NEW YORK 
HARCOURT, BRACE AND COMPANY 



L,.- 



HB't' 






COPYRIGHT, 1922, BY 
HARCOURT, BRACB AND COMPANY, INC. 



5% 



Printed in the U. S. A. 



INTRODUCTION 

The Theory of Economics does not furnish a body 
of settled conclusions immediately applicable to policy. 
It is a method rather than a doctrine, an apparatus of 
the mind, a technique of thinking, which helps its 
possessor to draw correct conclusions. It is not difficult 
in the sense in which mathematical and scientific 
techniques are difficult; but the fact that its modes of 
expression are much less precise than these, renders 
decidedly difficult the task of conveying it correctly to 
the minds of learners. 

Before Adam Smith this apparatus of thought 
scarcely existed. Between his time and this it has been 
steadily enlarged and improved. Nor is there any 
branch of knowledge in the formation of which English- 
men can claim a more predominant part. It is not 
complete yet, but important improvements in its 
elements are becoming rare. The main task of the 
professional economist now consists, either in obtaining 
a wide knowledge of relevant facts and exercising skill 
in the application of economic priaciples to them, or in 
expounding the elements of his method in a lucid, 
accurate and illuminating way, so that, through his 
instruction, the nimiber of those who can think for 
themselves may be increased. 

This Series is directed towards the latter aim. It 
is intended to convey to the ordinary reader and to the 
uninitiated student some conception of the general 



vi INTRODUCTION 

principles of thought which economists now apply to 
econonaic problems. The writers are not concerned to 
make original contributions to knowledge, or even to 
attempt a complete summary of all the principles of the 
subject. They have been more anxious to avoid ob- 
scure forms of expression than difficult ideas; and their 
object has been to expound to intelligent readers, 
previously unfamiliar with the subject, the most sig- 
nificant elements of economic method. Most of the 
omissions of matter often treated in textbooks are 
intentional; for as a subject develops, it is important, 
especially in books meant to be introductory, to discard 
the marks of the chrysalid stage before thought had 
wings. 

Even on matters of principle there is not yet a 
complete unanimity of opinion amongst professors. 
Generally speaking, the writers of these volumes be- 
lieve themselves to be orthodox members of the Cam- 
bridge School of Economics. At any rate, most of 
their ideas about the subject, and even their prejudices, 
are traceable to the contact they have enjoyed with the 
writings and lectures of the two economists who have 
chiefly influenced Cambridge thought for the past fifty 
years, Dr. Marshall and Professor Pigou. 

J. M. Keynes. 



CONTENTS 

CHAPTER I 
THE ECONOMIC WORLD 

PAGE 

§ 1. Theory and Fact . . . . . .1 

§ 2. The Division op Labor ..... 3 

§ 3. The Existence op Order ..... 5 

§ 4. Some Reflections upon Joint Products . . 7 

§ 5. Some Reflections upon Capital . . .11 

§ 6. The Fundamental Character op many Economic 

Laws 17 

CHAPTER II 

THE GENERAL LAWS OF SUPPLY AND DEMAND 

§ 1. Preliminary Statement op Three Laws . . 18 
§ 2. Diagrams and their Uses . . , . .21 
§3. Ambiguities op the Expressions, "Increase in 

Demand," etc. ....... 24 

§ 4. Reactions op Changes in Demand and Supply on 

Price 27 

§ 5. Some Paradoxical Reactions op Price Changes on 

Supply .30 

§ 6. The Disturbances op Monetary Changes . . 33 
§ 7. The Trade Cycle 34 

CHAPTER III 
UTILITY AND THE MARGIN OF CONSUMPTION 

§ 1. The Forces behind Supply and Demand . . 37 
§ 2. The Law of Diminishing Utility . . .40 

vii 



viii CONTENTS 

PAQB 

§ 3. The Relation Between Price and Marginal 

Utility ........ 43 

§ 4. The Marginal Purchaser . . . . .44 

§ 5. The Business Man as Purchaser . . .47 

§ 6. The Diminishing Utility op Money . , .49 

CHAPTER IV 

COST AND THE MARGIN OF PRODUCTION 

§ 1. An Illustration from Coal . . . .52 

§ 2. The Various Aspects op Marginal Cost . . 55 

§ 3. The Dangers op Ignoring the Margin . . 57 

§ 4. A Misinterpretation . . . . . .59 

§ 5. Some Consequences op a Higher Price Level . 60 

§6. General Relation Between Price, Utility and 

Cost 65 

CHAPTER V 

JOINT DEMAND AND SUPPLY 

§ 1. Marginal Cost under Joint Supply . . .66 

§ 2. Marginal Utility under Joint Demand . . 69 

§ 3. A Contrast Between Cotton and Cotton-seed, and 

Wool and Mutton ...... 71 

§ 4. The Importance of being Unimportant . . 74 

§ 5. Capital and Labor ...... 76 

§ 6. Conclusions as to Joint Supply and Joint Demand 79 

§ 7. Composite Supply and Composite Demand . . 79 

§ 8. Ultimate Real Costs . , . . .82 

CHAPTER VI 

LAND 

§ 1. The Special Characteristics of Land . . .83 
§ 2. The Scarcity Aspect . . . . . .84 



CONTENTS 



IX 



§ 3. The Differential Aspect 

§ 4. The Margin of Transference 

§ 5. The Necessity of Rent 

§ 6. The Question of Real Costs 

§ 7. Rent and Selling Price -: 



CHAPTER VII 

RISK-BEARING AND ENTERPRISE 

§ 1. Profits and Earnings of Management 

§ 2. The Payment for Risk-bearing . 

§ 3. Monte Carlo and Insurance 

§ 4. Risk under Large Scale Organization 

§ 5. The Entrepreneur .... 

§ 6. Risk-taking and Control 

§ 7. General Analysis of Profits 

CHAPTER VIII 

CAPITAL 

§ 1. A Reference to Marx 

§ 2. Waiting for Production 

§ 3. Waiting for Consumption 

§ 4. Capital not a Stock of Consumable Goods 

§ 5. The Essence of Waiting 

§ 6. Individual and Social Saving 

§ 7. The Necessity of Interest . 

§ 8. The Supply of Capital 

§ 9. Involuntary Saving .... 

§ 10. Interest and Distribution ... 

CHAPTER IX 

LABOR 

§ 1. A Retrospect on Laissez-faire 
§ 2. Ideas and Institutions 



page 

87 

94 

98 

100 

102 



104 
104 
105 
111 
113 
116 
117 



119 
120 
121 
123 
126 
127 
129 
130 
134 
137 



139 
141 



X CONTENTS 

PAGE 

§ 3. The General Wage-level ..... 143 

§ 4. The Supply op Labor in General. . . . 145 

§ 5. The Apportionment of Labor among Places . . 147 

§ 6. The Apportionment of Labor among Social 

Grades ........ 149 

§ 7. The Apportionment of Labor among Occupations 153 

§ 8. Women's Wages 157 

CHAPTER X 

THE REAL COSTS OF PRODUCTION 

§ 1. Comparative Costs ...... 162 

§ 2. The Allocation of Resources .... 166 

§ 3. Utility and Wealth ...... 170 

§ 4. Criteria op Policy 172 



SUPPLY AND DEMAND 

CHAPTER I 

THE ECONOMIC WORLD 

§ 1. Theory and Fact. The controversy between the 
"Theorist" and the "Practical Man" is common to 
all branches of hmnan affairs, but it is more than usually 
prevalent, and perhaps more than usually acrid in the 
economic sphere. It is always a rather foolish contro- 
versy, and I have no intention of entering into it, but 
its prevalence makes it desirable to emphasize a plati- 
tude. Economic theory must be based upon actual 
fact: indeed, it must be essentially an attempt, like all 
theory, to describe the actual facts in proper sequence, 
and in true perspective; and if it does not do this it is 
an imposture. Moreover, the facts which economic 
theory seeks to describe are primarily economic facts, 
facts, that is to say, which emerge in, and are concerned 
with, the ordinary business world; and it is, therefore, 
mainly upon such facts that the theory must be based. 
People sometimes speak as though they supposed the 
economist to start from a few psychological assumptions 
(e. g. that a man is actuated mainly by his own self- 
interest) and to build up his theories upon such founda- 
tions by a process of pure reasoning. When, therefore, 
some advance in the study of psychology throws into 

1 



2 SUPPLY AND DEMAND 

apparent disrepute such ancient maxims about human 
nature, these people are disposed to conclude that the 
old economic theory is exploded, since its psychological 
premises have been shown to be untrue. Such an 
attitude involves a complete misunderstanding not 
merely of economics, but of the processes of human 
thought. It is quite true that the various branches of 
knowledge are interrelated very intimately, and that 
an advance in one will often suggest a development in 
another. By all means let the economist and psychol- 
ogist avoid a pedantic specialism and let each stray 
into the other's province whenever he thinks fit. But 
the fact remains that they are primarily concerned 
with different things: and that each is most to be 
trusted when he is upon his own ground. When, 
therefore, the economist indulges in a generalization 
about psychology, even when he gives it as a reason for 
an economic proposition, in nine cases out of ten the 
economics will not depend upon the psychology; the 
psychology will rather be an inference (and very 
possibly a crude and hasty one) from the economic 
facts of which he is tolerably sure. 

But the purpose of economic theory is not merely to 
describe the facts of the economic world; it is to de- 
scribe them in their proper sequence and true per- 
spective. It must begin with those facts which are 
most general and which have the widest possible 
significance. Those are not likely to be the facts 
which our practical experience forces most insistently 
upon our notice. For it is the particular and not the 
general, the differences between things rather than their 
resemblances, that concern us most in daily life. Nor 



THE ECONOMIC WORLD 3 

are we likely to find the universal facts which we 
require in the sphere of public controversy. We must 
rather look for them in the dark recesses of our con- 
sciousness, where are stored those truths which are so 
obvious that we hardly notice them, which are so indis- 
putable that we seldom examine them, which seem so 
trite that we are apt to miss their full significance. 

§ 2. The Division of Labor. There is one such truth 
in the economic sphere which it is essential to appreciate 
vividly and fully, with the widest sweep of the imagina- 
tion and the sharpest clarity of thought. Man lives by 
cooperating with his fellow-men. In the modern 
world, that cooperation is of a boundless range and an 
indescribable complexity. Yet it is essentially un- 
designed and uncontrolled by man. The humblest 
inhabitant of the United States or Great Britain de- 
pends for the satisfaction of his simplest needs upon 
the activities of innumerable people, in every walk of 
life and in every corner of the globe. The ordinary 
commodities which appear upon his dinner table 
represent the final product of the labors of a medley of 
merchants, farmers, seamen, engineers, workers of 
almost every craft. But there is no human authority 
presiding over this great complex of labor, organizing 
the various units, and directing them towards the 
conamon ends which they subserve. Wheel upon 
wheel, in a ceaseless succession of interdependent 
processes, the business world revolves: but no one has 
planned and no one guides the intricate mechanism 
whose smooth working is so vital to us all. Man, in- 
deed, can organize and has organized much. Within 



4 SUPPLY AND DEMAND 

a large factory the efforts of thousands of work-people, 
each engaged on the repetition of a single small process, 
are fitted together so as to form an ordered whole by 
the conscious direction of the management. Some- 
times factory is joined with factory, with farms, fish- 
eries, mines, with transport and distributing agencies, 
as one gigantic business unit, controlled by a common 
will. These giant businesses are remarkable achieve- 
ments of man's organizing gifts. The individuals who 
control them wield an inamense power, which so im- 
presses the public imagination that we dub them 
"kings,*' *' supermen," "Napoleons of industry." But 
how small a portion of man's economic life is dominated 
by such men! Even as regards the affairs of their own 
businesses, how narrow, after all, are the limits of their 
influence! The prices at which they can buy their 
materials and borrow their capital, the quantities of 
their products which the public will consume, are 
factors at once vital to their prosperity and outside 
their own control. 

A great business, like a nation, may cherish visions of 
self-sufficiency, may stretch its tentacles forward to the 
consumer and backwards to its supplies of raw mate- 
rial; but each fresh extension of its activities serves only 
to multiply its points of contact with the outside world. 
When those points are reached, the largest business, 
like the smallest, is out on the open sea of an economic 
system immeasurably larger and more powerful than 
itself. There it must meet — ^the better perhaps for its 
inherent strength and accumulated knowledge — the 
impact of rude forces, which it is powerless to control. 
Beneath the blasts of a trade depression, or some other 



THE ECONOMIC WORLD 5 

tendency of world-wide scope, the authority of the 
mightiest industrial magnate, and equally of any 
Government, assmnes the same essential insignificance 
as the pride of a man humbled by contact with the 
elemental powers of nature. 

§ 3. The Existence of Order. The parallel can be 
pursued further with advantage. Just as in the world 
of natural phenomena, which for long seemed to man so 
wayward and inexplicable, we have come gradually 
to perceive an all-pervading uniformity and order; so 
there is manifest in the economic world, uniformity, 
order, of a similar if less majestic kind. Upon the 
cooperation of his fellowmen, man depends for the very 
means of life : yet he takes this cooperation for granted, 
with a complacent confidence and often with a naive 
unconsciousness, as he takes the rising of to-morrow's 
sun. The reliability of this unorganized cooperation 
has powerfully impressed the imagination of many 
observers. 

"On entering Paris which I had come to visit," 
exclaimed Bastiat some seventy years ago, "I said to 
myself — Here are a million of human beings who would 
all die in a short time if provisions of every kind ceased 
to flow towards this great metropolis. Imagination is 
baffled when it tries to appreciate the vast multiplicity 
of commodities which must enter to-morrow through 
the barriers in order to preserve the inhabitants from 
falling a prey to the convulsions of famine, rebellion, 
and pillage. And yet all sleep at this moment, and their 
peaceful slumbers are not disturbed for a single instant 
by the prospect of such a frightful catastrophe. On 



6 SUPPLY AND DEMAND 

the other hand, eighty departments have been laboring 
to-day, without concert, without any mutual under- 
standing, for the provisioning of Paris." 

The theme may well excite wonder. But wonder 
should always be watched with a wary eye; for he is 
apt to bring in his train a hanger-on called worship, 
who can do nothing but mischief here. It is a short step 
from a passage like that quoted above to a glorification 
of the existing system of society, to a defence of all 
manner of indefensible things; and a cross-grained 
attitude towards all projects of reform. It is a short 
step; but it is one which it is quite unjustifiable to take. 
For the evils of our economic system are too plain to be 
ignored; too many people have harsh personal experi- 
ence of the wastefulness of its production, the injustice 
of its distribution; of its sweating, its unemployment 
and slums. And when the attempt is made to plaster 
over evils such as these with obsequious rhetoric about 
the majesty of economic law, it is not surprising that the 
spirit of many men should revolt and that they should 
retort by denying the existence of order in the business 
world, by declaring that the spectacle which they see is 
one of discord, confusion and chaos. And then we are 
engulfed in a controversy as stale, flat and unprofitable 
as that between the "theorist" and the "practical 
man." 

The truth is that the language of praise and obloquy 
is quite inappropriate. In the first place, it may be well 
to note that the order of which I have spoken manifests 
itself not merely in those economic phenomena which 
are beneficial to man, but hardly less in those which 
work to his hurt. Even in those alternations of good 



THE ECONOMIC WORLD 7 

and bad trade, which spell so much unemployment and 
misery, there is discernible a rhythmic regularity like 
that of the process of the seasons, or the ebb and flow 
of the tide. This is not an elegance to be admired. Fur- 
thermore, in so far as the order comprises adjustments 
and tendencies which are beneficial (as, indeed, is 
mainly true), there is no warrant for assuming that these 
are either adequate to secure a prosperous community 
or dependent upon the social arrangements which hap- 
pen to exist. Let us, therefore, refrain from premature 
polemics and examine in a spirit of detachment some 
further aspects of the elaborate, but yet unorganized, 
cooperation of which so much has been already said. 

§ 4. Some Reflections upon Joint Products. A quite 
inadequate idea of the complexity of this cooperation 
is obtained by dwelling on the numbers of people who 
participate in it, or the immense distances over which it 
extends. The deficiency can be partially supplied by 
referring to some of the more obvious of the many 
subtle interconnections which exist between different 
commodities and different trades. 

There are innumerable groups of commodities (which 
it is customary to term '* joint products") such that the 
production of one conunodity belonging to the group 
necessarily implies or very greatly facilitates the pro- 
duction of the others. Wool and mutton; beef and 
hides; cotton and cotton-seed are a few famiUar illus- 
trations. The important feature of these "joint prod- 
ucts" is the fairly precise relation which must exist 
between the quantities in which the different products 
are supplied. If you plant a certain crop of cotton, it 



8 SUPPLY AND DEMAND 

will yield you so much cotton lint and so much cotton- 
seed. You can, of course, if you choose, throw away 
part of the seed, as indeed at one time planters used to 
do; but unless you do this, you cannot vary the pro- 
portions of the two things which you will have for sale. 
Similarly, if you keep a flock of sheep, or a herd of cattle, 
you will obtain wool and mutton in the one case, or beef 
and hides in the other, in proportions, which indeed you 
can vary within certain limits by choosing a different 
breed,^ but which you cannot radically transform. 
Wiien, however, we turn to the uses to which these 
products are put, no similar relation is to be discovered. 
Cotton lint is used chiefly for making articles of cloth- 
ing; cotton-seed for crushing into oil, on the one hand, 
and cake for cattle fodder on the other. There is no 
apparent connection of any kind between the demands 
for these different things, and still less is there any 
obvious reason why these demands should bear to one 
another the particular proportions which characterize 
their respective supplies. It is very much the same with 
wool and mutton; with beef and hides; with all "joint 
products." Why should we consume mutton on the 
one hand and woolen clothing on the other, in a ratio 
at all commensurate with that in wliich they are 
yielded by the sheep? 

What, then, might we expect to find if order was non- 
existent in the economic world? Surely that some 
things such as wool would be produced in quantities 
many times in excess of the demand for them, quite 

1 These possibilities of small variation are of very great impor- 
tance as will be shown in Chapter V, but they do not affect the 
present argument. 



THE ECONOMIC WORLD 9 

possibly five, ten, or twenty times in excess; while 
conversely the supplies of others such as mutton might 
fall far short of what was required. But in practice we 
find nothing of the sort. Somehow it comes about 
that an equilibrium is estabUshed between the demand 
for and the supply of every commodity; and that this 
applies to wool and mutton, to beef and hides, as surely 
as to commodities which are produced quite independ- 
ently. It is true that this equilibrium is a rough, 
imperfect one; and it may happen that what is called a 
"glut" of wool may co-exist for a short period with 
what is called a scarcity of mutton. But qualifications 
of this nature are in the strictest sense of the phrase, the 
exceptions which prove the rule. For the departures 
from equilibrium which gluts and scarcities represent 
are always transient and are usually confined within 
narrow Kmits. A strong prevailing trend towards an 
adjustment of demand and supply is unmistakably 
manifest amid all the vagaries of changing circumstance. 
Let me carry the argument a step further for the 
benefit of any reader who is restrained by a repugnance 
too deep and instinctive to be readily overcome, from 
admitting fairly to his mind that conception of order 
which I am endeavoring to emphasize. He will in all 
probabihty be one who, cherishing ideals of a better and 
fairer system of society, looks forward to a time when an 
organized cooperation will be substituted for what he 
regards as the existing chaos. Let us suppose that his 
visions were fulfilled as completely as he could desire; 
and that an immense system of Socialism were in exist- 
ence, embracing not one country only, but the whole 
world. Suppose all the difiiculties of human perversity 



10 SUPPLY AND DEMAND 

and administrative technique to have been surmounted 
and a wise, disinterested executive to be in supreme 
control of our business life. Let us suppose all this, and 
ask only the question: How would this executive treat 
the humdrum case of wool and mutton? How would 
it decide the number of sheep it would maintain? 

Shall we suppose that it is inspired by the ideal "to 
each according to his need," and that it resolves accord- 
ingly that the commodities which people require for a 
decent standard of life shall be supplied to them as a 
matter of course? How, then, would it proceed? It 
might estimate the amoimt of woolen clothing which a 
normal family requires, allowing for differences in 
climate, and possibly indulging somewhat the caprices 
of human taste. On this basis, a certain nimaber of 
sheep would be indicated. It might perform a similar 
calculation for mutton, and again a certain number of 
sheep would be indicated. But it would be an ex- 
traordinary coincidence if the numbers which resulted 
from these independent calculations were nearly equal 
to one another, or were even of the same order of mag- 
nitude; and, if they differed widely, what nmnber would 
our world executive select? Would it decide to waste 
an immense quantity of either wool or mutton; or 
would it decide that it could not, after all, supply 
the full human needs for one or other of the com- 
modities? 

Of course, if the executive were sensible it could solve 
the problem satisfactorily enough. It could retain the 
monetary system we know to-day and it could supply 
the commodities to the consimiers, not as a matter of 
right, but by selling them to them at a price. This price 



THE ECONOMIC WORLD 11 

it could then move upwards or downwards, raising, say, 
the price of mutton and reducing that of wool, until it 
found that the consumption of the two things was 
adjusted in the required ratio. But if it acted in this 
manner, what essentially would it be doing? It would 
be seeking by deliberate contrivance to reproduce, in 
respect of this particular problem, the very conditions 
which occur to-day without aim or effort on the part of 
anyone at all. 

The moral of this illustration must not be misin- 
terpreted. It does not show the folly of Socialism or the 
superiority of Laissez-faire. What it does show is the 
existence in the economic world of an order more 
profound and more permanent than any of our social 
schemes, and equally appKcable to them all. 

§ 5. Some Reflections upon Capital. Another aspect 
of the great cooperation is of even greater significance. 
It embraces not only a multitude of living men, but it 
links the present together with the future and the past. 
The goods and services which we enjoy to-day we owe 
only in part to the labors of the week, the month, or 
the year, only in part even to the efforts of our contem- 
poraries. The men, long since dead and forgotten, who 
built our railways, or sunk our coal mines, or engaged 
in any of a great variety of tasks, are still contributing 
to the satisfaction of our daily wants. The expression 
is not altogether fanciful; for, had it not been reasonable 
to expect that those labors would be of use to us to-day, 
many of them in all probability would never have been 
undertaken. It was to meet our present wants, and 
even our future wants, that many men toiled on monot- 



12 SUPPLY AND DEMAND 

onous tasks ten, twenty, thirty years ago. And yet, 
of course, we should deceive ourselves if we supposed 
that this was the motive of these men, that our welfare 
was the centre of their hearths desire. We in our turn 
dedicate to the future, a^nd often to a distant future, 
an immense portion of our energies. Let any reader 
who doubts this, study the statistics of the occupations 
of the people, and reflect on how long a period must 
elapse before the labors of this trade or that can fulfil 
their ultimate function. How long would the period be 
in the case of a man making bricks, which will later be 
employed in the erection of a factory, where machinery 
will be made, to equip an electrical generating station 
designed to supply, over a period of many years, Hght, 
heat, and power to people living in a remote Continent? 
A longer time, it may be hazarded, than he is accus- 
tomed to look ahead. 

Like the daily cooperation of living men, this coopera- 
tion of past, present and future is essential to the 
well-being of mankind, and yet it is undesigned and 
unorganized. As private individuals, men do, indeed, 
deliberately provide for their own future, and for that 
of their kith and kin: as the directors of businesses, 
they try to forecast the trend of demand. But such 
conscious calculations and deliberate acts would avail 
little if they stood alone. They are hardly more than 
the necessary spokes in the great wheel which regulates 
the relations of past, present and future. The hub of the 
wheel is an elaborate system of borrowing and lending, 
essentially similar to the buying and selling of com- 
modities. The private individual in order to provide 
for his family or for his old age "saves" and "invests." 



THE ECONOMIC WORLD 13 

But what exactly does this mean? It means that he 
transfers so much purchasing power, which he might 
have spent on his personal pleasures, to some one else 
in return for the expectation of receiving, year by year 
in the future, he and his heirs after him, a certain smaller 
quantity of purchasing power. The other party to 
the transaction will be, we may suppose, a business 
man who enters into it because he sees the opportunity 
of a promising industrial development, to undertake 
which he requires more purchasing power than he him- 
self possesses. And, because this transaction is entered 
into, a smaller number of us will shortly be engaged m 
making motorcars, or gramaphones, and a larger nmn-. 
ber of us in making factories and machinery, which will 
later enhance the world's productive power. 

Many transactions of the kind take place daily in 
modem communities, and their multipHcity gives rise 
to a mass of phenomena with which we are all tolerably 
famiUar. We recognize a short-loan market, a stock 
exchange, a munber of *' markets" where lenders and 
borrowers are brought together by the aid of various 
intermediaries, such as banks, bill brokers, and stock 
jobbers, who correspond to dealers in conmaodities. 
Between these different specialized markets, we are 
aware of an interconnection so close and strong that we 
speak more generally of a Capital Market, of which the 
stock exchange, the short-loan market and so forth, are 
the component parts. Now, "market" is a word which 
was originally used to denote a place where tangible 
commodities were bought and sold; and the more 
closely we examine the phenomena of the Capital 
Market, the more closely do we perceive the profound 



14 SUPPLY AND DEMAND 

resemblance between the mechanism of borrowing and 
lending, and that of buying and selling. Corresponding 
to the price of a commodity is the rate of interest (in 
the short-loan market we actually call the rate of dis- 
count "the price of money," and speak of money being 
cheap or dear); and between the rate of interest, the 
demand for and the supply of capital there exist rela- 
tions precisely similar to those between price, demand, 
and supply in commodity markets. Above all there is 
the same strong prevaihng trend towards an adjust- 
ment of demand and supply. 

This fundamental resemblance between two such 
apparently incommensurable things as the buying of 
material commodities and the borrowing of capital is 
highly significant; it is another instance of that order 
in the economic world, of which the reader may now 
be growing weary. But so difl&cult is it to see clearly 
and fully something which one sees, as it were, every 
day of one's life, that a few more moments of reflection 
on the special case of capital will be time well spent. 
Let us revert then to our fantasy of a world socialist 
commonwealth; and humbly submit another poser 
to its supreme executive. The question this time will be 
whether some great constructional work, such, let us 
say, as the recently mooted Severn barrage scheme, 
should or should not be undertaken. Let us suppose 
that the costs and future benefits of the undertaking 
can be estimated accurately; and that the problem 
reduces itself to one of expending now a sum, let us say, 
of $100,000,000, with the prospects of obtaining in the 
future an income of power, or whatever it may be, worth 
$5,000,000 per annum. I have assumed for the sake of 



THE ECONOMIC WORLD 15 

simplicity that we shall still be reckoning in terms of 
money, though possibly the executive may have 
substituted Marxian labor imits; but it is quite im- 
material to the present argument what the measuring 
rod may be. The point to be observed is, that it is 
impossible to tackle the problem at all without the 
conception of a rate of interest. For suppose that you 
tried to do without it, and said, "We shall take a long 
view. The interests of the future are no less our concern 
than those of the present; we shall not discriminate 
between them. We shall regard as an enterprise worthy 
to be imdertaken whatever promises to yield in the 
course of time a return larger than the outlay." Where 
will this lead you? The particular proposal set out 
above would clearly pass the test; for in twenty years 
the resultant benefits would have added up to a figure 
equivalent to the initial cost. But equally clearly, 
the cost might have been more than $100,000,000; it 
might have been $250,000,000, $500,000,000, whatever 
figure you care to take, and if you extend the period 
similarly to fifty or one hundred years, sooner or later 
the gains would top the cost. Now there is no limit to 
the enterprises which would pay their way on this 
basis; and it would be quite impossible to undertake 
them all. For they would swallow up all and more than 
all your labor and your materials, and would leave 
you with no resources with which to meet the recurrent 
daily wants of men. Clearly, then, in some way or 
other, you must pick and choose, you must reject some 
enterprises as insufficiently worth while. But how 
would you proceed to choose? Without a clear prin- 
ciple, a simple criterion to guide you, you would be 



16 SUPPLY AND DEMAND 

plunged in utter chaos. You could not say, "Let all 
proposals involving capital expenditure be submitted 
to a central committee, who shall compare them with 
one another in a sort of competitive examination and, 
after deciding the number of applications they can pass 
on the basis of the volume of resources which they can 
devote to the future, award the places to those which 
head the list." Such a prospect is a nightmare of 
officialism and delay. You would be driven to for- 
mulate a simple, intelligible rule or measure, and leave 
that rule to be applied by the unfettered judgment of 
innumerable men to individual problems, as and when 
they arose. And for such a rule or measure, you could 
not do better than a rate of interest; you would have to 
lay it down that only those projects should be ap- 
proved which promised a return of 6 per cent, or what- 
ever it might be. Even in deciding what it should be, 
the limits of your choice would be narrowly confined. 
If, for instance, you fixed on 1 or 2 per cent, you would 
probably discover that you had not achieved your 
object, that the undertakings for distant returns which 
passed this test, still consumed far more resources than 
you could spare. You would be compelled then to raise 
the rate until it had cut these enterprises down within 
manageable limits. But, once more, what essentially 
would you be doing? You would be using the instru- 
ment of the rate of interest to adjust the demand for 
and supply of capital, though indeed the interest might 
not be paid away as now to private individuals. You 
would be reproducing by the method of deliberate trial 
and error, the adjustments which occur automatically 
as things are, in the actual world. Once again the most 



THE ECONOMIC WORLD 17 

perfectly contrived Utopia would be compelled to pay 
to the unorganized cooperation of our epoch the sin- 
cerest flattery of imitation. 

§ 6. The Fundamental Character of many Economic 
Laws. But again perhaps a word of warning may be 
desirable. There is much controversy in these days 
about something called *' Capitalism" or "The capitalist 
system." When these words are used with any pre- 
cision, they usually refer to the arrangement so prev- 
alent at present, whereby the ownership and sole 
ultimate control of a business rests with those who hold 
its stocks and shares. There is much to be said upon 
the merits and demerits of this system; something will 
perhaps be said upon the matter in the fifth volume of 
this series; but I shall not discuss it here. Nothing 
that I have said so far has any real bearing on it what- 
soever; to suppose that it has, is indeed to miss the 
whole point of this chapter. 

The order, which I have sought to reveal, pervad- 
ing and moving the most diverse phenomena of the 
economic world, would be a far less noteworthy and 
impressive thing were it merely the peculiar product of 
capitalism. Merchant adventurers, companies, and 
trusts; Guilds, Governments and Soviets may come and 
go. But under them all, and, if need be, in spite of them 
all, the profound adjustments of supply and demand will 
work themselves out and work themselves out again 
for so long as the lot of man is darkened by the curse 
of Adam. 



CHAPTER 11 

THE GENERAL LAWS OF SUPPLY AND 
DEMAND 

§ 1. Preliminary Statement of Three Laws. The recogni- 
tion of order in any branch of natural phenomena is 
but the prelude to the formulation of a set of laws, 
the simpler as the order is more universal, which de- 
scribe, and as we say, explain it. Thus the perception 
of the even, elliptical courses of the heavenly bodies led 
to the statement of the law of gravitation and the laws 
of motion. 

In economics, similar laws have long since been 
enunciated, and have proved themselves such valuable 
instruments for the understanding of the daily problems 
of the workaday world, that they have been woven 
into the texture of our ordinary speech and thought. 
I have already touched upon them in the preceding 
chapter. But it is now desirable to set them out in 
order, in the most concise and formal manner possible. 

I. When, at the price ruling, demand exceeds 
supply, the price tends to rise. Conversely 
when supply exceeds demand the price tends 
to fall. 

II. A rise in price tends, sooner or later, to 
decrease demand and to increase supply. 
Conversely a fall in price tends, sooner or 

18 



GENERAL LAWS 19 

later, to increase demand and to decrease 
supply. 

in. Price tends to the level at which demand is 
equal to supply. 

These three laws are the cornerstone of economic 
theory. They are the framework into which all analysis 
of special, detailed problems must be fitted. Their 
scope is very wide. I have purposely refrained from 
introducing into my statement of them any reference 
to commodities; for they extend far beyond com- 
modities. Subject to an important qualification, they 
apply to capital, the price paid for the use of capital 
being what we call the rate of interest. They apply 
hardly less to "services," to the remuneration of labor 
of every kind and grade. People sometimes protest 
warmly against the idea of treating labor "like a com- 
modity." If this indignation expresses no more than a 
belief that in matters concerning conditions of work, 
and relations between employees and the management, 
the sensibilities of human nature should be taken into 
due account, it is based on elementary decency and 
commonsense. But if, as sometimes appears, it is 
directed against the fact that the remuneration of 
labor is controlled by the laws of supply and demand, 
it is a mere baying at the moon, with singularly little 
provocation. For these laws are in no way peculiar to 
commodities, and it is no one's fault that they include 
commodities too within their scope. 

But let us go back to the laws themselves, and probe 
them and dissect them, and turn them this way and 
that, so that we may perceive their full content, and 



20 SUPPLY AND DEMAND 

grasp it firmly in our minds. The third law implies a 
prevailing tendency for demand to be equal to supply. 
This tendency, as was suggested in Chapter I, can be 
verified by anyone from his experience and observation 
(provided he is a reasonable person, and not the tire- 
some kind who would dispute the law of gravitation 
because he sees that a feather falls to the ground more 
slowly than a stone). But it can also be deduced as a 
corollary from the two preceding laws; and to regard it 
in this way will help us to appreciate its significance. 
Start, for instance, by supposing that demand is in 
excess of supply. Then the price will tend to rise. After 
the price has risen, the supply will become larger, while 
the demand will fall away. The excess of demand 
with which we started will thus clearly be diminished. 
But if there remains any portion of this excess, the 
same reactions will continue; the price will rise further, 
and for the same reason; demand will be further 
checked and supply further stimulated. In other words, 
these forces must persist until the entire excess of 
demand over supply is eliminated. If we start by 
supposing supply to exceed demand, the converse chain 
of sequences will operate. Now these very simple steps 
of reasoning illuminate the nature of the normal equi- 
librium of demand and supply. They reveal that the 
equilibrium is established and maintained by the 
agency of changes in price, and they enable us to lay it 
down as perhaps the most important thing that can be 
said about the price of anything that it will tend to be 
such as will equate demand and supply. But that is not 
all that they reveal. They reveal also the extreme 
dependence of both demand and supply upon price. 



GENERAL LAWS 22 

Now this is a fact which it is most important to realize 
vividly. It is apt to be obscured by customary modes 
of speech. In ordinary times the prices of most com- 
modities and services do not change by very much, 
unless indeed over a long period of years; the amounts 
demanded and supplied may therefore seem to main- 
tain a fairly constant level; and we may be tempted to 
speak of Great Britain producing so many million tons 
of coal, or America consuming so many millions of 
motor-cars per annum, almost as though these quan- 
tities were independent of price considerations. But 
we should never forget that there is no service or com- 
modity produced by man, however essential it may 
seem, the demand for or the supply of which might not 
be reduced to nothing, if the price were sufl&ciently 
raised on the one hand, or lowered on the other. How 
easy it is sometimes to forget this simple truth may be 
seen from the mistake so commonly made of supposing, 
because the peoples of Central Europe were left, on the 
cessation of the war, starving and destitute of the 
means of life and the materials of work, that they must 
necessarily become heavy purchasers of imported 
goods; without pausing to consider whether the prices 
were such as they could afford to pay. 

§ 2. Diagrams and their Uses. It will help to prevent 
mistakes like this and more generally to make sharp and 
clear the fundamental relations which exist between 
demand, supply and price, if we exhibit them pictorially 
in the form of a diagram. Such diagrams are of great 
service in many parts of economic theory, not because 
they can prove anything which could not be proved 



22 



SUPPLY AND DEMAND 



otherwise, but because, being really a simpler medium 
of expression than words, they enable the mind to 
grasp more readily and to retain more vividly the essen- 
tial facts of complex relations. 

In Fig. 1 the curve DD' represents the conditions of 
demand. It is supposed to be drawn in such a way that 
if any point, Q, be taken on the curve, and the perpen- 




Fio. 1. 

dicular QN be drawn to meet the base line, or axis OX, 
then ON will represent the amount that will be de- 
manded at a price represented by QN (or 01). In other 
words, distances measured along OY represent prices, 
and distances measured along OX represent quantities 
of the commodity, or service, or whatever it may be. 
Clearly, then, the demand curve, DD', must slope 
downwards from left to right, since the lower the 
price asked, the greater will be the amount demanded. 
Similarly the curve SS' represents the conditions of 



GENERAL LAWS 23 

supply. It is supposed to be so drawn that if any 
point q be taken upon it, and the perpendicular qN 
be drawn to meet OX, then ON will represent the 
amount that will be supplied at a price represented by 
§N (or OA;). Equally clearly this supply curve must 
slope upwards from left to right, since the higher the 
price obtainable, the greater will be the quantity 
offered. Take the point P where the two curves meet, 
and draw the perpendicular PM to meet OX. Then 
the third law enunciated at the beginning of this 
chapter corresponds to the statement that PM or Om 
will represent the price at which the commodity or 
service will be exchanged. 

It can readily be seen that no other price could be 
maintained. For suppose the price to be less than Om, 
suppose it to be 0/c, then, at this price, ON (or kq) will 
be the amount supplied, and kr the amourlt demanded. 
The demand will thus exceed the supply, and the 
price will tend to rise, i. e. to move upwards towards 
Om. Similarly if we suppose the price to be 01, which 
is larger than Om, the supply (ZR) will exceed the 
demand (ZQ) and the price will fall downwards towards 
Om. Thus, again, we have deduced Law III from 
Laws I and II with the form and precision of a 
proposition in Euclid. Now, when once the eye has 
become familiar with this diagram, it ought to be 
impossible for the mind to lose even momentarily its 
grip on the fact that demand and supply are both 
dependent upon price. For these curves do not repre- 
sent any particular amounts; they represent a series of 
relations between amount and price; if the price is 
QN the amount demanded is ON, and so forth. The 



24 SUPPLY AND DEMAND 

terms demand and supply in the sense, in which I 
have been using them, of the respective amounts de- 
manded aiid suppHed are, indeed, strictly meaning- 
less without reference to some particular price. The 
reference may sometimes be implicit; but, whenever 
there is a chance of ambiguity, it should be explicitly 
made. 

§ 3. Ambiguities of the Expressions^ ^^ Increase in De- 
mand,''^ etc. It is the more important to be precise 
upon this point, in that there is a further possible 
confusion which we have now to consider. Demand 
and supply, as we have seen, are dependent upon 
price; but equally clearly they are dependent upon 
other things as well. Demand depends upon the needs, 
tastes and habits of the people, as well as upon the 
length of their purse; supply depends upon such things 
as the cost of production in the case of commodities. 
None of these things are constant factors, all of them 
are liable to change, and it may well happen that we 
shall want to consider in. some concrete problem the 
probable consequences of such a change. Now the 
most usual and natural way of describing such changes 
in the medium of words is to use the expression ''in- 
crease" or "decrease in demand," and "increase" 
or "decrease in supply," the same expressions, which 
we employed before to describe the consequences of a 
change in price. This identity of language conceals 
a fundamental distinction between the phenomena 
described; and to make this distinction plain we cannot 
do better than revert to our diagrammatic presentation 
of the laws. 



GENERAL LAWS 



25 



In Fig. 2 we start as before with our demand curve, 
and supply curve, cutting one another at the point P. 
We then suppose that some alteration takes place in 
the conditions of demand; there has been a growth 
in the general taste for the commodity or service, and 
the demand, as we say, has increased accordingly. 




Fig. 2. v. 

How is this fact to be represented in the diagram? 
Plainly not by taking another point on the curve, DD', 
at a further distance from OY. For this would merely 
indicate the larger amount that would be taken, if the 
conditions of demand had remained unaltered but the 
sellers had reduced their prices. The correct way of 
representing the change we have supposed is to con- 
struct a new demand curve (in the figure, the dotted 



26 SUPPLY AND DEMAND 

curve dd'), lying at every point above the old demand 
curve. For this indicates that larger quantities will 
be purchased at the old prices, which is exactly what 
we want to represent. Similiarly if we wish to represent 
a change in the conditions of supply, such as might 
result, in the case of a commodity, from a tax imposed 
on its production, we must draw a new supply curve, 
ss', which in the case supposed, must lie everywhere 
above the old supply curve. On the other hand, the 
decrease or increase in demand or supply, resulting 
from a change in price, is represented simply by a 
shifting of the equihbrium from one point to another on 
the same curve. The striking pictorial contrast be- 
tween a movement from one curve to another, and a 
movement along the same curve should help to make 
vivid to our minds the fundamental distinction between 
a change in the conditions of demand, arising from new 
tastes, enhanced purchasing power, etc.; and a mere 
change in the amount purchased resulting from an 
alteration in the price which the sellers ask. Words, 
as this necessarily cumbrous sentence shows, are a 
climisy instrument for the expression of abstract 
relations; it is not very easy to see which words in a 
sentence are the significant, commanding ones, and 
which are performing, as it were, ordinary routine 
duties. A diagram is not exposed to similar ambigui- 
ties of emphasis. 

The particular distinction, to which attention has 
been called, is important. The reader who has grasped 
it clearly will be able to perceive many instances of the 
confusion arising out of its neglect in the ordinary 
discussions of economic questions which take place 



GENERAL LAWS 27 

in the press and on the platform. It is not uncommon, 
for instance, for an argument to run something like 
this: "The effect of a tax on this commodity might 
seem at first sight to be an advance in price. But an 
advance in price will diminish the demand; and a 
reduced demand will send the price down again. It 
is not certain, therefore, after all, that the tax will 
really raise the price." A glance at the diagram will 
keep us out of such a bog of sophistry and muddle. 
For if we suppose the amount of the tax per unit of the 
commodity to be represented by Ss, the curve ss^ 
(drawn, as it is, roughly parallel to SS') will represent 
the new conditions of supply after the tax has been 
imposed. The new position of equilibrium will be 
given by the point P', where ss' cuts DD', the demand 
curve. Now P' lies to the left of P the old point of 
equilibrium; hence, since DD' must slope downwards 
from left to right, it is clear that, if, as it is fair here to 
assume, the conditions of demand have remained unal- 
tered, the new price P'M', must be greater than the old. 

§ 4. Reactions of Changes in Demand and Supply on 
Price. Having now made clear the meaning that must 
be attached to the terms, let us consider the question 
which naturally arises, whether we can lay down any 
general propositions or laws as to the effect upon 
price, of an increase or decrease in demand or supply. 
Another glance at the diagram suggests that we can. 
An increase in demand is represented in Fig. 2 by a 
movement from DD' to dd^, which cuts the supply 
curve, SS', at p, to the right of P. Since the supply 
curve (drawn, as it is best to draw it, to represent the 



28 SUPPLY AND DEMAND 

amount which will be supplied in response to a given 
price) must always slope upwards from left to right, 
the new price, pw, must be greater than the old, PM. 
Conversely a decrease in demand is represented by a 
movement from dd' to DD', and the new price is 
seen to be less than the old. We have already seen 
that a decrease in supply, which is represented by a 
movement from SS' to ss' results in a higher price; 
and it is the obvious converse that an increase in 
supply will have the opposite effect. It would seem 
then that we might lay down quite generally that an 
increase in demand or a decrease in supply will raise the 
price while a decrease in demand or an increase in 
supply will lower it. 

But here it is necessary to be cautious. All con- 
clusions as to the effects of causes are necessarily based, 
implicitly, if not explicitly, upon the assumption 
"other things being equal.' ' This method of reasoning, 
which some people appear to find so irritating in the 
economic sphere, and as they say so "theoretical'' 
and "unreal," is one which they adopt readily enough 
in every other department of life. No one, for instance, 
objects to the statement that the sun, when it comes 
out, makes a room wanner, although it may very- 
well happen, if a fire is dying at the same time, that 
the room grows colder in point of fact. For in our 
general statement we assume implicitly that "other 
things" such as fires, are unchanged. But assumptions 
of this kind are legitimate only when there is no reason 
to suppose that the cause, the effects of which are 
being studied, will itself produce a change in the "other 
things." If (as I have often been told; I really do not 



GENERAL LAWS 29 

know if it is true) the rays of the sun help to put a 
fire out, the statement made above would be the better 
for some qualification. 

Now we can only say that an increase in demand 
raises price if we assume the conditions of supply (as 
represented by the supply curve) to remain unchanged. 
But in practice, an increase in demand may cause a 
change in the conditions of supply. An increase, for 
instance, in the demand for a commodity may give rise 
to a revolution in the methods of production, to the 
introduction of labor-saving machinery and so forth, 
which will eventually result in the commodity being 
produced more cheaply. It will certainly take a con- 
siderable time before reactions of this kind can exert 
an appreciable influence; and we can, therefore, feel 
reasonably sure that over a short period an increase in 
demand will raise the price. But we cannot be sure 
wb'^t the ultimate effect will be. A similar alteration in 
tht condition of demand is less likely to result from an 
increase or decrease in supply; but it may conceivably 
occur. We must, therefore, be careful to qualify any 
general propositions which we lay down in this connec- 
tion, by explicit reference to a short period of time. 
We can add the following to our body of laws: — 

IV. An increase in demand, or a decrease in supply 
will tend to raise the price for a short period at 
least. Conversely a decrease in demand, or an 
increase in supply will tend to lower the price 
for a short period at least. 

This law, like the others, applies to commodities, 
services, capital, to anything which can be said, liter- 



30 SUPPLY AND DEMAND 

ally, or by analogy, to have a price. "A short period" 
is, however, a vague expression and, since precision is 
the hallmark of an important law, we must accord to 
this one a status inferior to that which the preceding 
three can rightly claim. 

§ 5. Some paradoxical reactions of price changes on 
supply. Let us turn, though, once more to these 
earlier laws, and with a heightened critical sense let us 
submit them to the test of the whole gamut of our 
experience, and see if in any of them we can find the 
smallest flaw. The first of them will pass through 
the ordeal — let each reader prove it for himself — 
unscathed. The second will emerge with a few hairs, 
as it were, singed. It tells us, for instance, that a rise 
in price will tend to augment the supply. Now there 
are some things the supply of which cannot possibly 
be augmented; these are the capital resources of nature, 
of which land is the most important for our present 
purpose. Land is bought and sold, it commands a 
price. In a certain sense, it may be said to be possible 
to increase the supply of land, in response to a rise in 
price, by drainage and reclamation schemes; and it 
will certainly happen that a rise in the price which 
land can command for any particular purpose will 
increase the amount which is devoted to that purpose. 
But, speaking broadly, the supply of land available 
for purposes of every kind is a fixed unvarying factor, 
with an inertia which the cajolery of price-changes is 
powerless to disturb. This is a most important fact, 
and it gives rise to some peculiar features of the price 
and rent of landj which we shall have to consider later 



GENERAL LAWS 31 

as a separate problem. It constitutes a limiting case 
rather than an exception to the general law. But we 
have not yet done with the reactions of price upon 
supply. In the case of capital, the nature of those re- 
actions has been much discussed as a highly controver- 
sial question. That a rise in the rate of interest will 
cause some people to save more than before, is gener- 
ally admitted ; but it is pointed out that the effect upon 
others may be the exact opposite, because it means that 
they do not need to save so much to acquire the same 
future annual income. It is unwise to say dogmatically 
that the former tendency outweighs the latter; though 
upon the whole it seems highly probable that it does. 
We cannot, therefore, in this case feel confident that a 
change in price will react upon supply in the manner 
which our law indicates. Similarly it is possible to 
argue that a rise in the general level of real wages may 
reduce the supply of labor, even, or some might say 
particularly, if the term is used to denote not the 
number of workpeople, but the quantity of work done. 
For there may be a tendency for workpeople, when 
more comfortably off, to work less regularly or less 
hard. Here again we cannot be sure. In none of 
these cases, however, including that of land, is there 
aRy reason to doubt that a rise in price will diminish 
demand, or conversely that a fall will increase it. Since, 
therefore, in the reasoning by which we deduced the 
third law, the conclusion will hold good, even if the 
effects of price-changes on supply are of the above 
paradoxical kind, provided that they do not con- 
tinually outweigh the effects upon demand, there is no 
reason to cast doubt on the solidity of Law III, which, 



32 SUPPLY AND DEMAND 

indeed, as we suggested before, commends itself directly 
to experience. But Law II seems now, perhaps, some- 
what the worse for wear. 

The damage, however, is not considerable. For in 
each case the uncertainty arises only when we are 
dealing with one of the factors of production, land, 
labor or capital, regarded as a whole. If we are dealing 
with the capital available for a particular industry, a 
rise in the rate of profit in that industry will certainly 
increase the supply of capital available there; for it will 
tend to attract savings that might otherwise have been 
employed elsewhere. We can even be fairly sure that 
an increase in the general rate of interest prevailing in 
any particular country will increase the total supply 
of capital available for the businesses of that coimtry, 
since capital has in modem times acquired a consider- 
able migratory power. In the case of labor, we cannot 
go so far as this; but here, too, there is no doubt that an 
increase in the remuneration offered in any particular 
occupation will attract an increased labor supply 
(always supposing, of course, that ''other things are 
equal"). No similar difficulty arises for land, labor 
or capital, as regards the effect of price-changes on 
demand; while for ordinary commodities there is no 
such difficulty on the side either of demand or of 
supply. Hence the only qualification which the 
strictest accuracy would require us in this connec- 
tion to attach to our statement of Law II is the 
postscript: — 

"Except that, in the case of land, the aggregate supply is 
unalterable; while in the case of capital or labor we cannot be 
sure how price-changes will affect the aggregate supply." 



GENERAL LAWS 33 

Much significance attaches to these exceptions, as 
later will appear. 

§ 6. The Disturbances of Monetary Changes. But let 
us still keep a critical eye on Law II, and submit it 
to another flashlight from our practical experience. 
The recent world war made us all acutely aware of a 
remarkable rise in the price of almost everything, 
which yet did not seem to diminish appreciably the 
demand. The explanation of this paradox is not 
difficult to find. There was an immense increase in the 
voliune of nominal purchasing power, due to a complex 
set of causes, of which "currency inflation" may be 
taken as the symbol. Now perhaps we are entitled to 
assume the absence of such currency changes as part of 
the "other things being equal" which is always under- 
stood as implied. But it is rash to take this particular 
assumption for granted, more especially in these days. 
Already people are too apt to speak as though the 
trade depression (which as these pages are written 
holds us in its grip) cannot pass away until pre-war 
prices are restored, ignoring altogether the great and 
probably permanent increase in nominal purchasing 
power which the war has left behind it. It would be 
safer, therefore, to add explicitly to Law II the reserva- 
tion, "Assuming that there is no change in the general 
volume of purchasing power." 

Monetary and allied questions will form the subject 
of the second volume of this series. It must not be 
supposed that our general laws have no bearing on 
them. On the contrary. Law I, which all this time has 
remained serene and undisturbed by the occasional dis- 



34 SUPPLY AND DEMAND 

comfitures of Law II, is the gateway through which all 
questions of currency, banking and the foreign ex- 
changes should be approached. It is well to note, as an 
inexorable corollary of Law I, that prices can rise only 
if demand exceeds supply, and fall only if supply ex- 
ceeds demand; and hence that it is only through the 
agency of changes in the demand for and supply of 
commodities and services that an inflation or deflation 
of the currency can influence the price level. Further, 
since a condition of things in which supply generally 
exceeds demand spells what we know and fear as a trade 
depression, it may be well to note at once that falling 
prices and unemployment are inseparable bedfellows. 
For we are far too apt to shut our eyes to these un- 
pleasant truths. But we cannot pursue them further 
here; and in the remainder of this volimie we shall 
not be concerned (except, perhaps, incidentally) with 
questions affecting the general level of prices or of pur- 
chasing power; but rather with the relation which the 
price of one commodity bears to that of another, with 
the rate of interest (which being a rate per cent is not 
essentially dependent on the price level), with ^^real" 
wages (as distinct from money wages) and the like. 

§ 7. The Trade Cycle. But our reference to trade 
depressions suggests a final comment on Law II. One 
small qualification was embodied in our original state- 
ment of it, namely the words "sooner or later." A rise 
in price may not check the demand immediately (even 
if the printing presses are standing idle in the Treas- 
uries); it may actually stimulate it for a time. For 
people may fear that the price will rise further still, and 



GENERAL LAWS 35 

hasten to buy what they must buy before very long. 
Sellers may share the same opinion, and be reluctant on 
their side to part. When prices are falling the roles are 
reversed, and we are Hkely to see the sellers tumbling 
over one another in a frantic eagerness to sell, the 
buyers wary and aloof. Sooner or later, indeed, these 
tendencies must dissolve and disappear; but they may 
persist for a longer period than might seem probable 
at first. For the raw material of one trade is, as we say, 
the finished product of another. The demand for one 
thing gives rise to a demand for other things, for the 
labor with which to make them, and so on in an ex- 
panding circle. A sympathy, subtle and intense, 
unites the business world, and a wave of depression or 
animation arising in any quarter may spread itself far 
and wide, heightened by the <5usts of human hope and 
fear, and continue long before its influence is spent. 

Here we are upon the threshold of one of the most 
striking and formidable of economic facts, the regular 
alternation of periods of good and bad trade, each very- 
widespread, if not world-wide, in its range, each com- 
prising certain regular phases of acceleration and decay, 
and each infallibly yielding sooner or later to the other. 
The details of these phenomena are highly complex, 
some of them obscure; an immense literature has 
already been devoted to the subject, yet its systematic 
study is hardly more than begun. The account given 
in the preceding paragraph is incomplete and meagre. 
It is inserted here in the hope that it will impress the 
reader with a sense both of the fact of these alternations 
and of the deeply rooted nature of the causes from which 
they spring. They take a heavy toll of human happi- 



36 SUPPLY AND DEMAND 

ness and wealth; and there is no object that more 
urgently calls for concerted human effort than that of 
mitigating them, and of alleviating the misery which 
they bring in their train. Still better, of eradicating 
them if that is possible; but let none suppose that it can 
be lightly done. Meanwhile, let us always remember 
that they form the atmosphere and medium in which 
the enduring tendencies of the business world must 
work themselves out. It is often convenient to speak of 
"normal conditions'' in this trade or that; but hardly 
ever can it be truly said of a particular moment that 
conditions are normal. The normal is rather a mean 
level about which oscillations to and fro, round and 
about, are constantly taking place, but which itself is 
reached only by accident, if at all. Whenever we say 
that some new factor should in the long run lower 
the price of this or that commodity or service, the 
picture which these words should convey to our mind 
is one of the price rising less on times of boom, and 
falling more in times of depression than is the case 
with other things. And if ever our faith in some 
honored economic law is shaken by the apparent ease 
with which, perhaps, in times of active trade, sellers are 
able to adv^ance their prices to whatever figure (so it 
almost seems) they choose to name, let us rally our 
sense of economic rhythm, and reserve our judgment 
until the trade cycle has run its course. 



CHAPTER III 

UTILITY AND THE MARGIN OF 
CONSUMPTION 

§ 1. The Forces behind Supply and Demand. The 
laws enunciated in the preceding chapter constitute 
the framework and skeleton of all economic analysis; 
but they do not carry us very far. It is only through 
the agency of these laws that any injBuence can affect 
the price of anything: but what influences may so 
affect it is a question which we have still to consider. 

Let us begin with ordinary commodities and ask our- 
selves, in the light of experience and cormnon sense, 
upon what factors their price seems mainly to depend? 
Two factors spring to mind at once; their cost of pro- 
duction and their usefulness. As regards the former, the 
case seems clear enough. We may indeed sometimes 
grumble that the price of this or that commodity is 
unconscionably high in comparison with its cost; but 
this only goes to show that we conceive a relation be- 
tween price and cost as the normal, governing rule. If 
one commodity cost only a half as much to produce as 
another, we should think that something had gone very 
wrong indeed, if the former commodity were sold for 
the higher price. But, when we turn to the usefulness 
of conmiodities, the case is not so clear. Usefulness has 
some connection with price, so much is certain; for an 
entirely useless thing, fit only for the dust-bin (and 

37 



38 SUPPLY AND DEMAND 

known to be such, it may be well to add) will fetch no 
price at all, however costly it may be to produce. But 
it is not easy to express the connection in quantitative 
terms. It seems reasonable enough to say that the 
prices of conmiodities are roughly proportionate to 
their costs of production. But directly we contemplate 
saying a similar thing of their usefulness, we are pulled 
up short. As we look round the world, and enumerate 
the commodities which by common consent are the 
most useful, salt, water, bread, and so forth, the strik- 
ing paradox presents itself that these are among the 
cheapest of all commodities; far cheaper than cham- 
pagne, motor-cars or ball-dresses, which we could very 
well get on without. As things are, of course, a ball- 
dress, or a motor-car costs more to produce than a loaf 
of bread or a packet of salt; and the common-sense 
explanation of the paradox seems, therefore, to be that 
the cost of production is a more weighty influence 
than the usefulness, or utility, as we will henceforth call 
it (so as to include the satisfaction we derive from not 
strictly useful things). We are thus tempted to con- 
clude that, provided a commodity possesses some utility, 
its price will be determined by the cost of production, 
the degree of utility being unimportant. This was ex-, 
actly how the position was summed up for many years 
in systematic treatises upon Political Economy; and 
it was not until fully half a century after the Wealth 
of Nations that a discovery was made which threw a 
fresh light on the whole matter. 

First of all, let it be clearly observed how very 
unsatisfactory is the above account. In Chapter II 
where we were treading surely, with a sense of solid 



UTILITY 39 

ground beneath us, we drew no such invidious dis- 
tinction between supply and demand. They seemed 
then to possess an equal status. But cost of production 
is the chief factor which, in the case of commodities, 
ultimately determines the conditions of supply. Util- 
ity, similarly, is the chief factor which ultimately de- 
termines the conditions of demand. Must not then the 
symmetrical relations between demand and supply be 
reflected in a corresponding symmetry between the 
utility and the costs which imderlie them? Demand 
springs obviously from utility; the only motive for 
buying anything is that it will serve some real or fancied 
use. Can we then accord to demand so dignified and 
to utility so subordinate a place? There is here an 
inconsistency which we must somehow reconcile. It 
will not serve as a solution to distinguish between 
different periods of time, and to say, as economists used 
to say not very long ago, that price is governed over a 
short period by demand and supply, but in the long run 
by the cost of production. This still leaves our sense of 
symmetry unsatisfied. Moreover, the conception of 
cost of production, when we consider it as ruling over 
a long period, frequently seems to lose any precision, 
as an independent factor, which it may otherwise 
possess. Motor-cars, we have agreed, are more costly 
to produce than loaves of bread; but, as we know well, 
the cost of producing motor-cars varies enonnously, 
accordingly as they are produced on a small or a large 
scale. By the methods of mass production they can be 
turned out at a relatively low cost per car. But this 
requires that they should be purchased in large numbers 
and this in turn throws us back to the demand for 



40 SUPPLY AND DEMAND 

motor-cars, and plainly enough, to people's judgment 
as to their utility. In some cases, the opposite phe- 
nomenon occurs. In the case of British coal, for in- 
stance, the average cost of production would be much 
lower than it is if the output were reduced to a fraction 
of its present volume, and if only the richer seams of the 
more fertile mines were worked. Once again, therefore 
it is difficult to measure the cost of production until we 
know the magnitude of the demand, which in a manner, 
which we have still to elucidate, clearly depends upon 
the utility. 

If we take the problem of joint products, the con- 
ception of cost of production fails us still more con- 
spicuously. For what is the cost of producing wool, 
or the cost of producing mutton? We can speak of 
the cost of rearing sheep: but it is hardly possible 
to allot this cost, except quite arbitrarily, between 
the two products. How, then, can we explain the 
separate* prices of these things by reference to cost 
alone? Instances of joint production are becoming so 
common in the modern world, or at least, with the 
growing attention to the utilization of by-products, are 
assuming so much more heightened a significance, that 
an explanation of price, which does not apply to them, 
is a very feeble one indeed. 

§ 2. The Law of Diminishing Utility. Let us turn 
back, then, to the factor of utility, and see if we cannot 
put on a more satisfactory basis the relation between 
utility and price. The clue to the puzzle is to be found 
in a brief reflection on the implications of the second 
general law propounded in Chapter II. A rise in price. 



UTILITY 41 

it was there stated, will sooner or later diminish the 
demand. This was asserted as a matter of fact, ob- 
served from and confirmed by experience. But what 
does it signify? To what causes is this familiar fact 
to be attributed? The first stage of the answer is very 
simple. The many individuals, whose purchases make 
up the demand for the commodity, will buy smaller 
quantities now that the price is higher. Possibly some 
of them may cease to buy it altogether; but as a rule 
it would be reasonable to suppose that most people con- 
tinue to buy a certain amount though a smaller amount 
than hitherto. Let us turn our attention, then, to the 
individual purchaser, and ask ourselves why he (or let 
us say she) acts in the manner indicated. The obvious 
answer is that the more she already has of anything, 
the less urgently does she require a little more of it. 
If she buys 6 pounds of sugar every week when the price 
is 7 cents a pound, but only 5 pounds when the price is 8 
cents, she shows by her action that she does not consider 
that the additional utility she will derive from buying 6 
pounds a week rather then 5 pounds is worth as much as 
8 cents. But she shows at the same time that she thinks 
it worth 7 cents. For, when the price is 7 cents, no one 
compels her to buy that sixth pound. She could stop, if 
she chose, at five; and it may serve to make the point 
quite plain if we suppose her actually to hesitate before 
she buys the sixth. She has hitherto, let us say, been 
buying 5 pounds a week at 8 cents. To-day she enters 
the shop and finds the price is down to 7 cents. She 
asks for her customary 5 pounds; then she pauses, and a 
minute later turns her order into six. What are the al- 
ternatives which she has been weighing one against the 



42 SUPPLY AND DEMAND 

other in that momentary pause? Not the utility of the 
whole 6 pounds of sugar against the total price of 42 
cents. For she has already ordered the first 5 pounds; 
and the decision to buy the sixth is taken independently 
and subsequently. She has been sizing up the increment 
of utility which a sixth pound would yield, and she de- 
cides that this is worth the expenditure of a further 7 
cents. Again, when the price was 8 cents she need not 
have bought as many as 5 pounds. She could have 
stopped at 4 had she chosen, and the fact that she did 
buy 5 pounds shows that the increment of utility de- 
rived from buying a fifth pound, when she might be said 
already to have 4, was worth at least 8 cents in her 
judgment. 

This trite illustration enables us to lay down two 
important laws relating to utility. To state them 
shortly, it is convenient to employ one or two technical 
terms, which, unlike every term employed hitherto, 
are not very commonly used in their present sense in 
everyday life. Their adoption is desirable not merely 
for the sake of convenience, but because they help 
to stamp clearly on the mind a most illimiinating 
conception, that of the "margin,*^ which supplies 
the clue to many complicated problems. The last 
pound of sugar which the housewife purchased, the 
fifth pound when the price was 8 cents, or the sixth 
pound when the price was 7 cents, we call the "mar- 
ginal'^ pound of sugar. And the increment of utility 
which she derives from buying this marginal pound 
we call the "marginal utility" of sugar to her. We 
are thus able to state the fact that the more a 
person has of anything the less urgently does he 



UTILITY 43 

require a little more of it, in the following formal 
terms: — 

V. The marginal utility of a commodity to anyone 
diminishes with every increase in the amount 
he has. 

The total utility will, of course, increase with an in- 
crease in the amount, but at a diminishing rate. This 
law is usually called The Law of Diminishing Utility^ 

§ 3. Relation between Price and Marginal Utility 
But this is not all. We are now in a position to per- 
ceive the true relation between ubiUty and price. The 
relation is one which exists not between price and total 
utility, but between price and marginal utility. If we 
know only that a housewife will buy weekly 5 pounds of 
sugar at 8 cents per pound, but 6 pounds at 7 cents, we 
know nothing of the total utility of sugar to her. We do 
not know how much she might be prepared to pay 
rather than go without 3 pounds, 2 pounds, or any sugar 
at all. But we do know that, when she buys 6 pounds, 
the marginal utility of sugar is in her judgment worth 
something which does not differ greatly from the price. 
We can, therefore, say in general terms that the price of 
a conmiodity measures approximately its marginal 
utility to the purchaser. 

This statement is perfectly consistent with the 
paradox noted above that the most useful commodities 
such as bread, salt and water are very cheap. For 
when we say that these commodities are supremely 
useful, we mean only that their total utility is very 
great; that, rather than do without them altogether, 
we would offer for them a large proportion of our means. 



44 SUPPLY AND DEMAND 

But we would not value very highly a small addition 
to the bread, water or salt that we habitually consume; 
nor would most of us feel it as a very serious depriva- 
tion if our consumption of these things were curtailed 
by a small percentage. In other words, their marginal 
utilities are small, and it is only the marginal utility 
that has any relation to price. 

§ 4. The Marginal Purchaser. A possible objection 
to the preceding argument deserves to be considered. 
Some readers may find the picture I have drawn of 
the hesitating housewife entirely unconvincing. They 
may declare that her mind does not work at all in 
the manner I have indicated. She will have formed 
certain habits in regard to her weekly purchases of 
sugar, which are connected very vaguely, if at all, with 
any conscious processes of thought. She will buy so 
many pounds of sugar weekly without troubling her 
head over the specific utility of the last pound she buys. 
When the price falls she may, indeed, buy more; but 
it will not be because she separates out and considers 
by itself the extra utility of an additional pound. She 
may buy more, because she has formed the habit of 
spending so much money on sugar; and now that the 
price has fallen, the same amount of money will enable 
her to buy more pounds. Or, perhaps, she may be 
moved by instinctive and irresistible attraction to buy 
more of a thing when it is cheaper, similar to that which 
inspires so many people to face with ardor the horrors 
of a bargain sale. In any case the fine calculations I 
have imagined convey a fantastic picture of her state of 
mind. And how much more fantastic, the critic mav 



UTILITY 45 

continue, of the state of mind in which things of a 
different kind are bought by less careful people. When, 
for instance, one of us happy-go-lucky males (more 
liberally supplied, perhaps, than the housewife with the 
necessary cash), decides to buy a motor bicycle, or to 
replenish his stock of collars or ties, does the above 
analysis bear any resemblance to the actual facts? In 
the case of the motor bicycle, the purchaser may, in- 
deed, weigh the price fairly carefully against the pleas- 
ure and benefit, though contrariwise he may be a rich 
, enough gentleman hardly to bother about this. But, 
one motor bicycle is as much as he is at all likely to buy, 
and what becomes, then, of the distinction between 
total and marginal utility? In the case of the ties and 
collars, the vaguen^M of many of us about the price will 
be extreme. We pf^ably have been uneasily conscious 
for some time of an inconvenient shortage of these 
troublesome articles and eventually will go off (or 
perhaps will be sent off with ignominy) to the nearest 
suitable shop to make good the deficiency. How can 
we speak here with a straight face of the relation be- 
tween marginal utility and price? 

These are very pertinent criticisms; but they do 
not make nearly as much nonsense of the notion of 
marginal utility as may seem at first. The last point, 
indeed, serves rather to give it a fresh aspect of much 
significance. Those of us who do not bother about the 
price we pay for our ties and collars owe a debt of grati- 
tude, of which we are insufficiently conscious, to the 
more careful people who do; as well as to the custom 
which prevails in shops in Western countries (as dis- 
tinct from the bazaars of the East) of charging as a 



46 SUPPLY AND DEMAND 

rule a uniform price to all customers. If we were the 
only people who bought these things, an enterprising 
salesman would be able to charge us very much what 
he chose. He could put up his price, and we would 
hardly be aware of it. And, as by lowering his price he 
could not tempt us to buy any more, price reductions 
would be few and far between. But fortunately there 
are always some people who do know what the price 
is, even when they are buying collars and ties; and who 
will adjust the amount they buy in accordance with the 
price. It is these worthy people who make the laws 
of demand work out as we well know they do. It is 
they who will curtail their consumption if the price has 
fallen and it is they who constitute the seller's problem, 
and help to keep down prices for the rest of us. The 
Test of us — it is well to be quite blunt about it — simply 
do not count in this connection. We have no cause 
then to plume ourselves that we have disproved the 
truth of economic laws when we declare that we seldom 
weigh the utility of an3rthing against its price. All 
that this shows is that our actions are too insignificant 
to be described by economic laws since they exert no 
appreciable influence on the price of anything. And 
this in turn shows the extreme importance of grasping 
clearly the conception of the margin. Just as it is 
the marginal purchase, so it is the marginal purchaser 
who matters. It is the man who, before he buys a 
motor bicycle, weighs the matter up very carefully 
indeed and only just decides to buy it, whose demand 
affects the price of motor bicycles. It is the utility 
which he derives that constitutes the marginal utility, 
which is roughly measured by the price. 



UTILITY 47 

As to the housewife, I am not prepared to concede 
that my picture is in essentials very fanciful. She may 
be a creature of habits and instincts like the rest of 
us, but most habits and instincts affecting household 
expenditure are based ultimately on some calculation, 
if not one's own, and reason has a way of paying, as 
it were, periodic visits of inspection, and pulling our 
habits and instincts into line, if they have gone far 
astray. I am not satisfied that the housewife does not 
envisage the utility of a sixth pound of sugar as some- 
thing distinct from the utility of the other five; she 
may buy it, for example, with the definite object of 
giving the children some sugar on their bread, and she 
may have a very clear idea as to the price which sugar 
must not exceed before she will do any such thiag. 
Possibly I may exaggerate. I have the profound 
respect of the incorrigibly wasteful male for the care 
and skill she displays in laying out her money to the 
best advantage. 

§ 5. The Business Man as Purchaser. But if the reader 
still finds the picture unconvincing, let us shift the 
scene from domestic economy to commerce, and sub- 
stitute for the careful housewife an enterprising business 
man. Now, as anyone who has a business man for his 
father will have often'heard him say, the vagueness and 
caprice which characterize our personal expenditure 
would be quite intolerable in business affairs. There 
you must weigh and measure with the utmost possible 
precision. You must be for ever watching the several 
channels of your expenditure, careful to see that in 
none does the stream rise higher than the level at which 



48 SUPPLY AND DEMAND 

further expenditure ceases to be profitable. You will 
Dot even engage typists or install a telephone in your 
office without weighing up fairly carefully the number 
of typists or the number of switches that it is worth 
your while to have. And in deciding whether to employ 
say, five typists, or six, you will not vaguely lump the 
services of the whole six typists together, and consider 
whether as a whole they are worth to you the wages 
you must give them. You will, in the most direct and 
literal manner, weigh up the additional benefit you 
would derive from a sixth typist, and if that does not 
seem to you equivalent to her wage, you will not engage 
her, however essential it may be to you to have one or 
two typists in your office. If on the other hand, the 
utility of having a sixth typist seems to you worth 
much more than her pay, the chances are that you will 
'be well advised to consider the employment of a seventh. 
And so, where you stop employing further typists, 
the utility to you of the last one, of the '^ marginal 
typist" as it were, is unlikely to differ greatly from her 
pay. 

Now this is not a fancy picture of some remote 
abstraction called an ''economic man.'' Allowing for 
the over-emphasis which is necessary to drive home the 
central point, it is a bald account of the aims and 
methods of the actual man of business. To ascertain 
the margin of profitable expenditure in each direction, 
to go thus and no further, is the very essence of the 
business spirit, as the business man himself conceives 
it. When he condemns the extravagance of Govern- 
ment departments, it is their lack of just this marginal 
sense that he chiefly has in mind. "The lore of nicely 



UTILITY 49 

calculated less or more" may be rejected by High 
Heaven and Whitehall, but no one can afford to despise 
it in the business world. 

The transition from household to business expendi- 
ture involves an extended use of the word utility, which 
is worth noting. Commodities like bread, sugar, or 
privately owned motor-cars are sometimes called 
''consumers' goods" in contrast to ''producers' goods," 
which comprise things such as raw materials, machin- 
ery, the services of typists and so forth, which are 
bought by business men for business purposes. The 
line of division between the two classes is not a sharp 
one, and we need not trouble with fine-spun questions 
as to whether a particular commodity should in certain 
circumstances be included under the one head or the 
other. But, broadly speaking, things of the former 
type yield a direct utility; they contribute directly to 
the satisfaction of our pleasures or our wants. Things 
of the latter type yield rather an indirect utility. Their 
utility to the business man who buys them lies in the 
assistance they give him in making something else from 
which he will derive a profit. The utility of these' 
things is therefore said to be derived from that of the 
consumers' goods or services to which they ultimately 
contribute. This conception of derived utility leads to 
certain complications which we shall have to notice 
later. 

§ 6. The Diminishing Utility of Money. But one 
important point must be emphasized in this chapter. 
The utility which a business man derives from the 
things which he buys for business purposes is the extra 



50 SUPPLY AND DEMAND 

receipts which he obtains thereby. Derived utility, 
in other words, is expressed in terms of money, and the 
idea of its relation to price presents no difficulty. But 
the utility of things which are bought for personal 
consumption means the satisfaction which they yield, 
and this is clearly not a thing which is commensurable 
with money. When, therefore, it is said that the prices 
measure their respective marginal utilities, what exactly 
is meant? What was it that the argument of § 3 went 
to show? That the utility of the marginal pound of 
sugar would seem to the housewife just worth the price 
that she must pay for it; in other words, that it would 
be roughly equal to the utility she could obtain by 
spending the money in other ways. The respective 
marginal utilities which she obtains from the different 
things she buys will thus be proportionate to their 
prices. But if she were to receive a legacy which gave 
her a much larger income to spend, she might buy 
larger quantities of practically every commodity; and, 
though she would obtain a greater total utility therebj^, 
the marginal utility she would obtain in each direction 
would be smaller, in accordance with the law of dimin- 
ishing utility. The prices might not have changed; 
the respective marginal utilities to her of the different 
things would again be proportionate to their prices, 
but they would constitute a smaller satisfaction than 
before. 

Thus we can only say that the prices of commodities 
will be proportionate to their real marginal utilities, 
when we^are considering the different purchases of 
one and the same individual. The amounts of money 
which different people are prepared to pay for dif- 



UTILITY 51 

ferent consumers* goods are no reliable indication 
of the real utilities, the amounts of human satisfaction 
which they yield. Here we must take account not 
only of varying needs and capacities for enjoyment, 
but of the very unequal manner in which purchasing 
power is distributed among the people. The cigars 
which a rich man may buy will yield him an immeasur- 
ably smaller satisfaction than that which a poor family 
could obtain by spending the same amount of money 
on boots, or clothes or milk. When, therefore, we 
compare commodities which are bought by essentially 
different consuming publics, their respective prices may 
bear no close relation to their real utility, whether 
marginal or otherwise. Thus the law of diminishing 
utility applies to money or purchasing power, as well 
as to particular commodities. The more money a 
man has the less is the marginal utility which it yields 
him; and, where the marginal utility of money to a 
man is small, so also will be the real marginal utility 
he derives in each direction of his expenditure. The 
extreme inequality of the distribution of wealth gives 
immense importance to this consideration. Its practical 
implications will be discussed m Chapter V. Mean- 
while, we may express the conclusions of the present 
chapter by the statement that the price of a commodity 
tends to equal its marginal utility, as measured in terms 
of money, i. e. relatively to the margiaal utility of money 
to its purchaser. 



\ 



CHAPTER rV 

COST AND THE MARGIN OF PRODUCTION 

§ 1. An Illustration from Coal, We have already 
had occasion to note the symmetry which characterizes 
the relations of demand and supply to price. This 
symmetry was apparent throughout the argument 
of Chapter II, and it was a striking feature of the 
diagrams which we employed to illustrate the argument. 
We shall do well to cultivate a lively sense of this 
symmetry, for it will frequently save us from ignoring 
factors which have a vital bearing on the problems 
we are considering. We should never leave an impor- 
tant feature of demand without turning to see whether 
it has a counterpart on the supply side, though indeed 
we may not always find one. In the last chapter we 
examined the relation between utility and price, and 
found that the true relation was between the price and 
what we termed the marginal utility. Corresponding 
to utility on the demand side is cost of production 
on the supply side. The question should thus at once 
suggest itself — "Can we speak appropriately of the 
marginal cost of production, and will this serve to 
make clear the relation between cost and price?" To 
answer these questions, let us take one of the in- 
stances in which we found that price could not be 
explained satisfactorily by the bare phrase "cost of 

production." 

52 



COST AND THE MARGIN OF PRODUCTION 53 

An important feature of the coal industry, which 
recent events have brought into sharp prominence, 
is the great diversity of conditions between different 
coalfields and different collieries. We speak of rich 
seams and poor seams, of fertile and unfertile mines, 
and we are aware that the costs of raisiag coal to the 
surface differ very widely in accordance with these 
diverse natural conditions. Nor must we confine our 
attention to the cost price at the pit-head. If we wish 
to speak of cost of production as a factor determining 
price, we must use the term in a broad sense to include 
the transport and other charges necessary to bring 
the coal to market. 

In this respect also one coalfield differs greatly from 
another. Some are well situated close to a large market, 
or within easy reach of the seaboard; others must 
incur very heavy transport charges to bring their coal 
to any considerable centre of consumption. These 
varying conditions lead, as we well know, to great 
variations in the financial prosperity of different colliery 
concerns. In Great Britain, under the abnormal 
conditions which prevailed during the war, and sub- 
sequently, these variations were so huge as to constitute 
a most formidable embarrassment and to contribute, 
more perhaps than any other single factor, to the 
unrest and instability by whi^h the industry has been 
afilicted. But they are always with us, if usually upon 
a more modest scale. 

What, then, is the normal relation between price and 
cost in the case of coal? Should we direct our attention 
to the average costs over the whole industry, or the 
costs incurred by the richer and better situated mines, 



64 SUPPLY AND DEMAND 

or, lastly, that of the poorer and worse situated? 
Now, as things are, it is clear enough that no concern 
will continue indefinitely producing at a loss. It may 
do so for a time, rather than close down altogether, 
hoping to recoup itself later when the market has 
taken a more favorable turn. But, in the long run, 
taking good years with bad, it must expect to obtain 
receipts sufficient not only to cover its necessary 
expenditure, but to provide also a reasonable profit 
on the capital employed. Of course, once the capital 
has been sunk and embodied in plant and buildings, 
which are of little use for any other purpose, a business 
may continue for many years, with a rate of profit 
far below what it had anticipated. But plant and 
buildings gradually wear out, and need to be replaced; 
the course of technical improvement calls continually 
for fresh capital outlay, which a business in a bad way 
is reluctant to imdertake. The tendency, therefore, 
when profits rule low over a considerable period, is 
for the plant to fall gradually into disrepair and 
obsolescence, and finally for the business to disappear. 
We can thus include an ordinary rate of profit under the 
head of cost of production, and say with substantial 
accuracy that for no business can this cost for long 
exceed the price if the business is to continue to exist. 
If then the relatively poor and badly situated mines 
are to be worked, the price of coal, taking good years 
together with bad, must cover the costs at which these 
mines can produce. If the price rules lower than this, 
sooner or later they will close down, and we will be left 
with a smaller number of mines, among which great 
variations of conditions will still prevail. Once more, 



COST AND THE MARGIN OF PRODUCTION 55 

the price must cover the cost incurred by the least 
profitable of these remaining mines, unless their number 
is still further to be diminished. Thus we can conceive 
of a ^'margin of production" which will shift backwards 
to more profitable or forwards to include less profitable 
mines, according as the demand for coal contracts 
or expands. But, wherever this margin may be, there 
is no escaping the conclusion that it is the cost of 
production of the "marginal mines," of those that is 
to say which it is only just worth while to work, to 
which the price of coal will approximate. 

It follows that there is no real connection between 
price and cost of production throughout the industry 
as a whole. It follows incidentally that those concerns 
which can market their coal at an appreciably lower 
cost than the marginal concerns, are likely to reap 
more than an ordinary rate of profit, though royalties 
may absorb part of the excess. 

§ 2. The Various Aspects of Marginal Cost. This 
relation cuts much deeper than the particular system 
imder which the mines are at present owned and worked. 
If, for instance, we supposed that the various mines 
were amalgamated together in a few giant concerns, 
each of which comprised some of the richer and some 
of the poorer mines, the preceding argument would 
need to be recast in form, but its substance would be 
unaffected. For though a great coal trust could in a 
sense afford to sell at a price lower than the marginal 
cost, setting its losses on the poorer against its gains 
on the better pits, is it likely it would do so? Why 
should it dissipate its profits in this way? It is clearly 



56 SUPPLY AND DEMAND 

more reasonable to suppose that it would close down 
the poorer pits (unless it could advance the price of 
coal), and thereby maintain its profits at a higher figure. 
If, indeed, the mines were nationalized the deliberate 
policy might be pursued of selling coal at a price which 
left the industry no more than self-supporting as a 
whole. Some coal might thus be sold at less than its 
cost price, and the selling price would conform roughly 
to the average cost. But such a policy, though in special 
circumstances it might be justified, would represent a 
very dangerous principle, which could not be applied 
widely without the most serious results. Nothing 
could be more fatal to any enterprise, whether it be 
in the hands of an individual, a joint-stock company, 
a State department, or a Guild, than that the manage- 
ment should content themselves with results which 
in the lump seem satisfactory, and regard losses 
here or there with an indifferent eye. That way lies 
stagnation, waste, progressive ineflaciency and ultimate 
disaster. To inquire searchingly into every nook and 
cranny of the business, to construct, as it were, for 
each part a separate balance-sheet of profit and loss, 
to expand in those directions where further develop- 
ment promises good results, and to curtail activity 
where loss is already evident, is the very essence of good 
management. Here, it will be observed, we are using 
language very similar to that in which we described 
the principles which govern a business man's expendi- 
ture. The resemblance is inevitable and significant, for 
we are dealing here with what is essentially another 
aspect of the same thing. The object is to secure that 
nowhere does expenditure fail to yield a commensurate 



COST AND THE MARGIN OF PRODUCTION 57 

return. This we express, when we consider a business in 
its aspect as a consumer, by saying that its consumption 
of anylihing will not be carried beyond the point at 
which the marginal utility exceeds the price it will 
have to pay. When we consider it as a producer, we 
say that its production of anything will not be carried 
beyond the point at which the marginal cost exceeds 
the pri<je it will obtain. ^ 

§ 3. The Dangers of Ignoring the Margin. This at least 
is the general rule. A business may decide deliberately 
to sell part of its output below cost, because, for in- 
stance, this will serve as an advertisement, bring it con- 
nections, and enable it to obtain a larger profit at a later 
date, or immediately on other portions of its sales. In 
so acting, it recognizes that the price obtained for a 
thing may be an inadequate measure of the real return 
it yields. In the same way, though for different reasons, 
a nationalized coal industry might conceivably be 
justified in selling some coal below cost price, be- 
cause, let us say, it held that the price which the 
immediate purchasers were willing to pay was an 
inadequate measure of the utility of coal to the com- 
munity as a whole. But in all such cases it is essential 
to be very clear as to what exactly you are doing; so 
that you may be at least moderately clear as to whether 
the policy is well advised. It may be sound enough to 
lose on the swings and make good this loss on the 
roundabouts, but only if your loss on the swings helps 
you to a larger profit on the roundabouts. If you 
would get the same return on the roundabouts in any 
case, it would be better to cut the swings out altogether. 



58 SUPPLY AND DEMAND 

So, if you are directing the policy of a nationalized coal 
industry, and decide to make a loss on a portion of 
your sales, you will need to know that the indirect 
benefit which the community will derive from this 
particular part of your coal output is worth the loss 
which you incur. You will certainly come to grief, if 
you pursue a vague ideal of lumping all results together, 
and regarding a profit somewhere as a sufiicient excuse 
or a positive reason for making a loss elsewhere. 

It is quite true that in big undertakings, where there 
are large standing charges, and where the organization 
possesses some of the characteristics of an integral 
whole, it is not easy to measure accurately the specific 
costs which should be assigned to any particular 
portion of the output. But this difficulty is one of the 
most serious weaknesses of large undertakings; precise 
detailed measurement is the great prophylactic of 
business efficiency, and, where it is lacking the bacilli 
of waste will enter in and multiply. So clearly is this 
recognized, that the development of large scale business 
has led to the evolution of new methods of accountancy, 
designed to make detailed mensuration possible. We 
have most of us heard of them vaguely under such 
names as *' comparative costings," but too few of us 
appreciate their full significance. It is hardly too 
much to say that the issue as to whether the size of the 
typical business unit will continue to become larger and 
larger, or whether it has already overshot the point of 
maximum efficiency will turn largely upon the capacity 
of accountancy to supply large and complex under- 
takings with more accurate instruments of detailed 
financial measurement. 



COST AND THE MARGIN OF PRODUCTION 59 

§4. A Misinterpretation. The price, then, of a com- 
modity tends roughly to equal its marginal cost of 
production; and this marginal cost (in perfect sym- 
metry with what we observed as regards marginal 
utility), may be conceived as applying either to the 
marginal producer or to the marginal output of any 
producer. In the former aspect it is open to a mis- 
interpretation, against which it will be well to guard. 
Some advocates of socialism have argued, as one of the 
counts in their indictment of the present industrial 
system, that the price of a commodity is determined by 
the cost at which the least efficient concern in the 
industry can produce. They say, in effect, "Under 
the present competitive regime, you have to pay for 
everything you buy a price which far exceeds the 
necessary cost to a concern which is managed with 
ordinary ability. For, as economic theory has shown, 
it is the cost of the marginal concern, i. e. the concern 
m.anaged by the most incompetent, and half-witted 
fellow in the trade; it is the cost incurred by him, 
together with a profit on his capita|i, that the price has 
got to cover. The producer of no more than average 
capacity is therefore making out of you a surplus profit, 
which would be quite unnecessary m any well-arranged 
society." Such an argument is a gross caricature of 
the marginal conception. The half-witted incompetent 
will, as we know well enough, speedily disappear under 
the stress of competition, and his place will be taken 
by more efficient men. There is an essential difference 
between him and the "marginal coal mine" of which 
we spoke above. For the probabilities are that of the 
coal resources, whose existence is clearly known, the 



60 SUPPLY AND DEMAND 

more fertile and better situated parts will already be in 
process of exploitation; and there is not likely, there- 
fore, to be a supply of substantially better seams which 
can be substituted for the worst of those in actual use. 
There is likely, on the other hand, to be available a 
supply of decent business capacity which can be substi- 
tuted for the most inefficient of existing business men. 
The marginal concern, in other words, must be con- 
ceived as that working under the least advantageous 
conditions in respect of the assistance it derives from 
the strictly Hmited resources of nature, but under 
average conditions as regards managerial capacity and 
human qualities in general. Thus in agriculture we can 
speak of a marginal farm, which we should conceive as 
the least fertile and worst situated farm which it is just 
worth while to cultivate (of which more will be said 
when we come to the phenomenon of rent), but we 
must assume it to be cultivated by a farmer of average 
ability. 

§ 5. Some Consequences of a Higher Price Level. The 
foregoing controversy will be of service to us, if it 
makes clear the manner and the spirit in which the 
marginal conception should be handled. It should be 
regarded not as a rigid formula which we can apply 
to diverse problems without considering the special 
features they present, but rather as a signpost which 
will enable us to find our way, a compass by which we 
may steer between the shoals of triviality and sophistry 
to the crux of any problem with which we have to deal. 
Let us illustrate its practical uses by an example which 
is of great interest and far-reaching practical importance 



COST AND THE MARGIN OF PRODUCTION 61 

at the present day. As has been already observed, the 
war has left behind it in all countries a great and almost 
certainly permanent increase in nominal purchasing 
power. Since the armistice prices have moved upwards 
and downwards with unprecedented violence; and it 
would be very rash to prophesy the precise level at 
which they will ultimately settle (using that word with 
considerable relativity). But, for reasons for which the 
reader is referred to Volume II in this series, it is safe 
enough to say that the general level of post-war will 
greatly exceed that of pre-war prices. Now this will 
apply not only to consumers^ goods like milk and 
clothes, or to raw materials hke pig-iron and cotton, 
but in very much the same degree to things like 
factories and machinery. Things of this last type are 
sometimes called ''capital goods," because it is in them 
that a large part of the capital of a business is embodied. 
Now the fact that it will cost much more than it did 
before the war to construct fresh capital goods, has a 
significance which very few people appreciate. An 
existing factory cost, let us say, $500,000 to build and 
equip with machinery before the war. To construct a 
similar factory to-day would cost, let us assume (it 
is probably a moderate assumption) $1,000,000. Sup- 
pose 10 per cent to be the gross profit that is necessary 
to attract capital to the particular industry. Then it 
will not pay to construct this new factory unless the 
trade prospects point to the probability of a profit of 
about $100,000 per annum. But if the old factory is 
equally well managed, it too should be able to earn this 
$100,000, which upon the capital actually sunk would 
represent a rate of 20 per cent. The particular figures 



e2 SUPPLY AND DEMAND 

given are, of course, purely illustrative; the con- 
clusion to which they point is that, if new enterprises 
are to be undertaken, pre-war enterprises are likely to 
yield a rate of profit, on their fixed capital at least, 
increased in rough proportion to the price-level. Of 
course, in years when trade is bad, the factory which 
dates from pre-war times will not earn a profit of this 
kind, it may very likely make an actual loss. At those 
times it is very certain that few new factories will be 
erected. But it is difficult to reconcile a condition of 
trade activity, in which the constructional industries 
are busily employed, with a rate of profit to pre-war 
businesses on the fixed part of their capital of a lesser 
order of magnitude than has been indicated. It makes 
no difference, it should be observed, whether we suppose 
the new enterprises to take the form of starting of 
new concerns or extending old ones; in neither case 
will they be undertaken, unless there is reason to 
expect an adequate return on the capital which they 
require at post-war constructional prices. High profits 
(taking always good years together with bad) on capital 
sunk before the war in buildings and machinery are 
thus a likely consequence of an increase in the price- 
level. 

This fact is, indeed, the counterpart or complement 
of another phenomenon with which we are more 
familiar. While prices are actually rising, profits, as we 
have come to recognize, necessarily rule high, because 
every trader or manufacturer is constantly in the 
position of selling at a higher price-level, stock which 
he purchased, or goods made from materials which he 
purchased at a lower level. He thus acquires an ab- 



COST AND THE MARGIN OF PRODUCTION 63 

normal profit on his circulating capital, which is 
essentially similar to the profit on fixed capital, which 
we have just examined. The difference is that the 
former profit is crowded into the years when prices are 
actually on the increase, and thus is very noticeable 
indeed; while the latter ^profit continues to accrue in 
smaller instalments after prices have settled down, as 
it were, at the higher level, and is not exhausted until 
the buildings and machinery have become obsolete. 
But the two profits are essentially similar, and in the 
long run should be commensurate. In the one case, 
stock can be sold for a large profit, because it cannot 
be replaced except at a higher price; in the other case, 
plant and buildings yield a higher income because they 
cannot be replaced except at a higher price. Indeed, 
if the owners choose, the plant and building can, like 
the stock, be sold at their appreciated value, as has been 
widely done by the owners of cotton mills in Great 
Britain since the armistice. 

There is nothing in these considerations that should 
surprise us, or even shock our moral sense. For what 
they have indicated is an increase of money profits in 
rough proportion to the price-level, so that the aggre- 
gate profits will represent about as much real income as 
before.-^ The conclusion therefore amounts to no more 
than this, that you cannot alter fundamentally the 
distribution of wealth between labor and capital by 
merely inflating the currency, or otherwise juggling 

^ Assuming that the rate of interest has remained unaltered. 
In fact it has greatly increased since pre-war days, and this points 
to a stni further increase of money profits, and an increase in the 
real income which they represent. See Chapter VIII, p* 138. 



64 SUPPLY AND DEMAND 

with the price-level. And this is only what we should 
expect, if there are any laws of distribution of sufficient 
importance and permanence to justify the many vol- 
umes which have been devoted to them. 

But this somewhat tame conclusion does not make 
it any less important to grasp clearly the significance 
of the appreciation in the value of capital goods. A 
failure to realize it lies at the root of our bewildered 
muddling of many crucial problems of the day. In 
the matter of housing, for instance, we know we cannot 
build houses at less than two or three times their pre- 
war cost, and yet we cannot endure to see the owners 
of pre-war houses obtaining a commensurate increase 
of rent. And so, in Great Britain, we pass Rent Restric- 
tion Acts, and Housing Acts, and then, in a fit of 
economy we suspend the latter, and let the former 
stand, while the housing shortage becomes steadily more 
acute. When we hand the railwaj^s back from State 
control to private hands, our horror at the idea of the 
companies receiving larger money profits than they did 
before the war leads us to lay down principles for the 
fixing of fares and freight charges, which take no 
account of post-war construction costs; and then, in 
alarm lest we may have thereby made it unprofitable 
for the companies to spend a single penny of fresh 
capital upon further development, we seek to provide 
for capital expenditure by cumbrous and dubious 
expedients. Doubtless we shall muddle through some- 
how with such policies: and, public opinion being what 
it is, they may perhaps have been about the best 
policies that were practiable. But the problems would 
have been easier to handle, if the public generally were 



COST AND THE MARGIN OF PRODUCTION 65 

a little less disposed to think in terms of averages, and 
a little more in terms of margins, if we all of us instinc- 
tively realized that the cost that rtally matters is the 
cost at which additional production is proiBtable under 
the conditions ruling at the time, or in the immediate 
future. 

§ 6. General Relation between Price, Utility and Cost, 
Let us conclude this chapter by summing up the con- 
clusions which have emerged as to the relations of 
utility and cost to price. 

The price of a commodity is determined by the con- 
ditions of both supply and demand; and neither can 
logically be said to be the superior influence, though 
it may sometimes be convenient to concentrate our 
attention on one or other of them. The chief factor on 
which the conditions of demand depend is the utility 
(as measured in terms of money). The chief factor 
on which the conditions of supply depend is the cost 
of production (again as measured in terms of money). 
The prevailing trend towards an equilibrium of demand 
and supply can thus be expressed as follows: — 

VI. A commodity tends to be produced on a scale 
at which its marginal cost of production is 
equal to its marginal utility, as measured in 
terms of money, and both are equal to its 
price. 



CHAPTER V 

JOINT DEMAND AND SUPPLY 

§ 1. Marginal Cost under Joint Supply. Several refer- 
ences have been made above to joint products, a rela- 
tion which it will be convenient now to describe as that 
of Joint Supply. Our sense of symmetry should make 
us look for a parallel relation on the side of demand; and 
it is not far to seek. There is a ''joint demand" for 
carriages and horses, for golf clubs and golf balls, for 
pens and ink, for the many groups of things which we 
use together in ordinary life. But the most important 
instances of Joint Demand are to be found when we pass 
from consumers' to producers' goods. There, indeed, 
Joint Demand is the universal rule. Iron ore, coal and 
the services of many grades of operatives are all jointly 
demanded for the production of steel; wool, textile 
machinery and again the services of many operatives 
are jointly demanded for the production of woollen 
goods (to mention in each case only a few things out 
of a very extensive list). Now we have already noted 
that, when commodities are jointly supplied, there is 
an obvious difficulty in allocating to each of them its 
proper share of the joint cost of production. There is 
a similar difficulty in estimating the utility of a com- 
modity which is demanded jointly with others. Thus, 
the utility of wool is derived from that of the woollen 
goods which it helps to make. But the utility of the 
factories, the machinery and the operatives employed in 
the woollen and worsted industries is derived from pre- 

66 



JOINT DEMAND AND SUPPLY 67 

cisely the same source. How much, then, of the utility of 
woollen goods should be attributed to the wool and how 
much to the textile machinery? Can we make any sense 
of the notion of utility as applying to one of these things, 
taken by itself? And, if not, how can we explain the 
price of a thing like wool in ternos of utility and cost, 
since we cannot disentangle its cost from that of mutton, 
nor its utility from that of a great variety of other things? 
Here the conception of the margin enables us to 
grapple with a problem which would otherwise be 
insoluble. For, while it is impossible to separate out 
the total utility and cost of wool, it is not impossible 
to disentangle its marginal utility and its marginal cost. 
The proportion in which wool and mutton are supplied 
cannot be radically transformed; but it can be varied 
within certain limits, by rearing, for instance, a different 
breed of sheep. Variations of this kind have been an 
important feature of the economic history of Austral- 
asia, where sheep farming is the leading industry. Be- 
fore the days of cold storage, Australia and New Zealand 
could not export their mutton to European markets, 
though they could export their wool. Wool was accord- 
ingly much the most valuable product; the mutton was 
sold in the home markets, where, the supply being very 
plentiful, the price was very low. In the circumstances, 
the Australasian farmers naturally concentrated on 
breeding a variety of sheep whose wool-yielding were 
superior to their mutton-yielding qualities. The 
development of the arts of refrigeration led in the 
eighties to an important change. It became possible to 
obtain relatively high prices for frozen mutton in over- 
seas markets. There was, therefore, a marked tendency, 



68 SUPPLY AND DEMAND 

especially in New Zealand, to substitute, for the merino, 
the crossbred sheep which yields a larger quantity of 
mutton and a smaller quantity of wool of poorer quality. 
Now if we calculate the cost of maintaining the number 
of merino sheep which will yield a given quantity of 
wool, and calculate the cost of maintaining the larger 
Dumber of crossbred sheep which will be required to 
yield the same quantity of wool (allowing for differences 
of quality) the extra cost which would be incurred in the 
latter case must be attributed entirely to the extra 
mutton that would be obtained. This extra cost we can 
regard as constituting the marginal cost of mutton. 
So long as this marginal cost falls short of the price 
of mutton, it will be profitable to extend further the 
substitution of crossbred for merino sheep. The process 
of substitution will in fact be continued until we reach 
the point at which the marginal cost is about equal to 
the price. Similarly by starting with the numbers of 
merino and crossbred sheep which would yield the same 
quantity of mutton, we can calculate the marginal cost 
of wool; and again the tendency will be for this mar- 
ginal cost to be equal to the price. ^ 

^ It may be found difficult to grasp this point when stated in 
general terms. The following arithmetical example may make it 
plainer: — 

Suppose a merino sheep yields 9 units of mutton and 10 units of 
wool. 

Suppose a crossbred sheep yields 10 units of mutton and 8 units 
of wool. 

Suppose, further, that a merino sheep and a crossbred sheep 
each cost the same sum, say, for convenience, £10, to rear and 
maintain; and that there are no special costs assignable to the 
wool and the mutton respectively, as, of course, in fact there are. 

Then 10 merino sheep, yielding 90 units of mutton +100 units 



JOINT DEMAND AND SUPPLY 69 

§ 2. Marginal Utility under Joint Demand. On the side 
of demand there exist as a rule similar possibilities of 
variation. Some machinery, some labor, some mater- 
ials of various kinds, are all indispensable in the produc- 
tion of any manufactured conamodity. But the propor- 
tions in which these factors are combined together can 
be varied, and are frequently varied in practice as the 
result of the ceaseless pursuit of economy by business 
men. To produce pig-iron, you need both coal and 
iron ore; but, if coal becomes more costly, it is possible 
to economize its use. Machinery and labor must be 

of wool, cost £100; while 9 crossbred sheep, yielding 90 units of 
mutton +72 units of wool, cost £90. 

Hence you could obtain an extra 28 units of wool for an extra 
cost of £10, by maintaining 10 merino sheep rather than 9 cross- 
bred sheep. The marginal cost of wool is thus £^|- per unit. 

Similarly 8 merino sheep, yielding 72 units of mutton +80 units 
of wool, cost £80; whUe 10 crossbred sheep, yielding 100 units of 
mutton +80 units of wool, cost £100. 

Hence you could obtain an extra 28 units of mutton for an extra 
cost of £20, by maintaining 10 crossbred sheep in place of 8 mer- 
inos. The marginal cost of mutton is thus £f|- per unit. 

So long as the price obtainable for wool exceeds £^f , and that 
obtainable for mutton does not exceed £f f per unit, it will pay to 
substitute merino for crossbred; and conversely. If the price of 
wool exceeds £^^ and the price of mutton also exceeds £f g, it will 
be profitable to expand the supply of both breeds, until as the 
result of the increased supply, one of the above conditions ceases 
to obtain. Conversely, if the prices of both products are less than 
the figures indicated, sheep farming of both kinds wiU be re- 
stricted. The resultant of the processes of expansion or restric- 
tion, and substitution, will be that, unless one of the breeds is 
eliminated, the prices of mutton and wool wiU equal their respec- 
tive marginal costs. These marginal costs may, of course, alter 
as the process of substitution extends. For the relative cost of 
maintaining merinos and crossbreds will not be the same for 
every farmer. Here again it is the costs at the ** margin of sub- 
stitution" that matter. 



70 SUPPLY AND DEMAND 

used together, in some cases in proportions which are 
absolutely fixed. But there is in nearly every industry 
a debated question as to whether the introduction of 
some further labor-saving machine would be worth 
wliile, or some improved machine which would represent 
the substitution of more capital plus less labor for less 
capital plus more labor. A farmer can cultivate his 
land, to use a common expression, more intensively or 
less intensively; in other words, he can apply larger 
or smaller quantities of capital and labor (the propor- 
tion between which he can also vary) to the same 
amount of land. The problem is essentially the same as 
that of the substitution of the crossbred for the merino. 
We can take the various possible com.binations of the 
factors of production, and contrast two cases in which 
different quantities of one factor are employed, together 
with equal quantities of the others. The extra product 
which will be yielded in the case in which the larger 
quantity of the varying factor is employed can then be 
regarded as the marginal product (or marginal utility) 
of the extra quantity of that factor; and we can say 
that the employment of this factor will be pushed 
forward to the point where this marginal product 
will be roughly equal to the price that must be paid 
fQr'4t. "We can thus lay down the most important 
proposition that the relation between marginal utility 
and price holds good generally of the ultimate agents 
of production; that the rent of land, the wages of 
labor, and, we can even add, the profits of capital tend 
to equal their (derived) marginal utilities, or, as it is 
sometimes expressed, their marginal net products. 
Whenever, therefore, the proportions in which two or 



JOINT DEMAND AND SUPPLY 71 

more things are produced or used together can be 
varied, the relations of joint supply and joint demand 
are perfectly consistent with a specific marginal cost 
and marginal utility for each commodity. 

§ 3. A contrast between Cotton and Cotton-seed, and 
Wool and Mutton. But it sometimes happens that such 
variations cannot be made. Thus, it has not been 
found possible (so far as I am aware) to alter the 
proportions in which cotton lint and cotton-seed are 
yielded by the cotton plant. Roughly speaking, you 
get about 2 pounds of cotton-seed for every 1 pound of 
cotton lint (or raw cotton), and though this proportion 
may vary somewhat from plantation to plantation, it is 
upon the knees of the gods, and not upon the will of the 
planter that the variation depends. We cannot, there- 
fore, speak with accuracy of the separate marginal costs 
of raw cotton and cotton-seed. It is true that some 
plantations are so far distant from any seed-crushing 
mill that it is not worth while to sell the seed as a 
commercial product; and it might seem, therefore, 
as though we might regard the entire costs of cotton 
growing on such plantations as constituting the mar- 
ginal costs of raw cotton. But planters, so situated, 
derive a considerable value from their cotton-seed by 
using it as fodder for their live stock or as a manure. 
You can, of course, argue that proper allowance is 
automatically made for this factor, as a deduction from 
the costs of raw cotton, when you add up the expenses 
of the plantation. In the same way you can deduct the 
price which a planter who sells his cotton-seed obtains 
for it, from the total costs of the plantation, and call the 



72 SUPPLY AND DEMAND 

remainder the costs of the raw cotton. But this is 
really to reason in a circle. For in either case the 
magnitude of the deduction depends on the marginal 
utility of the cotton-seed. And the notion of the cost 
of anything becomes blurred and blunted if we so use 
it that it must be deduced from the utility of something 
else, which is not an agent in the production of the 
thing in question. 

This point is not merely an academic one. It means 
that we cannot explain the relative prices of cotton 
lint and cotton-seed in terms of cost at all, whether 
marginal or otherwise. The influence of cost will be 
confined to the sum of the prices of the two things. 
Upon this sum it will exert precisely the same influence 
as it exerts upon price in general, by affecting the total 
quantities of the two things that will be supplied. But 
upon the distribution of this sum between lint and 
seed, cost will exert no influence whatever, because it 
cannot affect the proportions in which they are supplied. 
It may assist some readers if I state the matter in more 
concrete terms. Cost of production will be one of the 
factors which will result in the production of an annual 
cotton crop in the United States of, let us say, 10 million 
tons of seed cotton. This crop will yield roughly 6| 
million tons of cotton-seed, and 3|- million tons (or 
rather more than 13 million bales) of lint. The com- 
bined price received by the planter of (let us say) 14.4 
cents for 1 pound of hnt plus 2 pounds of seed should 
correspond roughly to the marginal joint costs of pro- 
duction. But the factor of cost has no influence at all 
in determining that this combined price is made up of 
a price of 12 cents per pound for lint, and only 1.2 cents 



JOINT DEMAND AND SUPPLY 73 

per pound (or $24 per ton) for cotton-seed. To account 
for this we must rely entirely upon demand. We can 
say, shortly, that the respective prices must be such as 
will enable the demand to carry off 6| million tons 
of seed, and S^ million tons of raw cotton. Or we 
can go further and say that the marginal utility of a 
pound of raw cotton, when 3^ million tons are sup- 
plied, is ten times as great as that of a pound of seed 
when 6f million tons are supplied. 

If accordingly the demand for cotton-seed were to 
expand considerably owing, say, to the discovery of 
some new use for the oil, which is its most valuable con- 
stituent; the effect would be first a rise in the price of 
cotton-seed, and, subsequently, by stimulating cotton 
growing, a more plentiful supply and a lower price for 
raw cotton. And so far at least as the increased supply 
is concerned, this must necessarily be the effect, " other 
things being equal"; though, to be sure, it might be 
outweighed and obscured by other influences such as the 
boll-weevil. But it is not the case that an increased 
demand for mutton must necessarily increase the supply 
or lower the price of wool; and it is most unhkely 
to do so in any similar degree. For, here, the separate 
marginal costs of the two things exert their influence. 
An increased demand for mutton will stimulate sheep 
farming, but it will also stimulate the substitution of 
crossbred for merino breeds; and the resultant of these 
two opposite tendencies upon the supply of wool is 
logically indeterminate. As a matter of history we know 
that the development of cold storage in the eighties 
(which we may regard for the present purpose as equi- 
valent to an increased demand for Australian mutton) 



74 SUPPLY AND DEMAND 

caused considerable perturbation in the woollen and 
worsted industries of Yorkshire. They were faced with 
a dwindling supply and a soaring price of merino wool; 
and the adaptability with which they met the situation, 
and won prestige for the crossbred tops, and yarns and 
fabrics, to which they largely turned is a matter of 
just pride in the trade to-day. The fact, however, that 
this alteration in the supply of wool was a matter not 
only of quantity but of quaUty, while it takes nothing 
from the substance of the preceding argument, makes 
it difficult to draw a clear moral, bearing on the present 
issue, from this incursion into history. 

§ 4. The Importance of being Unimportant. The above 
contrast between cases in which variation is possible, 
and those in which it is not possible, is reproduced with 
a heightened significance when we turn back to joint 
demand. The cases are perhaps less common in which 
it is impossible to alter the proportions in which different 
commodities are jointly demanded, but there are many 
cases in which it is not nearly worth while to do so 
(and this amounts to very much the same thing). 
Cases of this sort are especially likely to occur when we 
are dealing with a commodity which accounts for only 
a tiny fraction of the costs of the industry which is its 
chief consumer. Sewing cotton, for example, is jointly 
demanded, with many other things, by the tailoring 
and other clothing trades; but the money which these 
trades spend on sewing cotton is so small a part of 
their total expenditure, that no ordinary variation in 
its price is likely to make it worth while to study the 
ways and means of using it in smaller Quantities. When 



JOINT DEMAND AND SUPPLY 75 

sewing cotton is bought by the domestic consumer, 
considerations which are fundamentally the same, 
though somewhat different in form, point to a similar 
conclusion. It is thus very difficult to assign to sewing 
cotton a specific marginal utility. This difficulty is of 
great importance in connection with the possibilities 
of monopolistic exploitation. For it means that the 
demand blade of the scissors upon which we rely to cut 
off excrescences of price is blunted, and if accordingly 
the producers constitute a strong enough combination 
to control the supply blade, they will possess an unusual 
power of advancing their selling prices as they choose. 
I am far from suggesting that Messrs. J. & P. Coats 
are to be condemned as an extortionate monopoly. 
On the contrary, during 1919, when the profits in highly 
competitive industries like the main branches of the 
cotton and woollen trades, soared exuberantly, the 
record of this concern seems to me one of distinct 
moderation. But the present point is that they possess 
an exceptional power to fix the price of sewing cotton 
as they choose, and that this is attributable in no small 
degree to the fact that sewing cotton constitutes an 
essential but relatively trifling item in the expenses of 
the processes in which it is employed. 

Perhaps the point will be made clearer if we turn 
from the selling prices of commercial products, in regard 
to which there is a strong and not ineffective public 
sentiment against "profiteering,'^ to the remuneration 
of different classes of labor. With an instinctive dis- 
position towards megalomania, it is often claimed in 
Great Britain that the miners, being a very numerous 
and well-organized body of workpeople, were in a 



76 SUPPLY AND DEMAND 

stronger strategic position than most workpeople 
for exacting the remuneration they desire. It is 
quite true that a stoppage of work in the coal in- 
dustry causes us a high degree of inconvenience, 
and temporary concessions may thereby be obtained 
which might otherwise have been refused. But this 
is a dubious advantage, and we grossly exaggerate 
its real importance. The truth is that the strategic 
position of the miners in regard to wages questions is 
by no means strong. For their wages constitute a very 
large percentage of the cost of coal; and the price of coal 
in its turn is a most important element in the costs of 
many of the industries which are its principal con- 
sumers. Great Britain, moreover, is far from possessing 
a monopoly of coal. If, accordingly, the wages of the 
miners are temporarily pushed up to a high point, the 
result will certainly be a diminished demand for British 
coal, which will lead before long to their fighting a losing 
battle to maintain the concessions they have won. 
Contrast their position with that of the steel smelters, 
whose wages (high though the wage rates are) constitute 
a very small percentage of the costs of steel production, 
and we must agree I think that we have in this distinc- 
tion the main reason why the steel smelters, though 
they hardly ever go on strike, have as a rule been 
able to do so much better for themselves than the 
miners. 

When a commodity or service is such that an appreci- 
able alteration in its price has only a slight effect upon 
the quantity demanded, the demand is said to be 
inelastic. Conversely, when a small change in price 
greatly alters the quantity demanded, we call the 



JOINT DEMAND AND SUPPLY 77 

deniaad_^^^^c. In the former case, it is worth nothing, 
a larger aggregate sum of money will be spent upon the 
thing when its price is high than when it is low, while 
the opposite is true in the latter case. This distinction 
is of considerable importance in connection with many- 
problems (e. g. of taxation); and the terms, elastic 
demand and inelastic demand, are worth remembering. 
We may thus express the above conclusions by saying 
that the demand for sewing-cotton is highly inelastic, 
and that the demand for coal miners is more elastic than 
that for steel smelters. 

§ 5. Capital and Labor. Cases in which it is imprac- 
ticable to make any variation in the proportions in 
which different things are used together are, however, 
the exception rather than the rule. Where variation 
is possible, we are confronted with an uncertainty as to 
the way in which an increased supply of one thing will 
react on the demand for another, similar to our uncer- 
tainty as to whether an increased demand for mutton 
would augment or diminish the supply of wool. It is, 
for instance, of the highest importance to give a clear 
answer, if we can, to the question whether an increased 
supply of capital will increase the demand for labor. 
The chief effect of an increased supply of capital is to 
facihtate the extended use of expensive machines: to 
some extent these machines will increase the demand 
for labor; to some extent they will be substituted for 
it. Which of these two tendencies will outweigh the 
other we cannot be absolutely sure. But fortunately 
we can be far more nearly sure than was possible in the 
analogous case of wool and mutton. An increase in the 



78 SUPPLY AND DEMAND 

supply of capital increases the demand for the com- 
modities, from which the demand for labor is derived, 
in both the senses discussed in Chapter II. First it 
makes them cheaper to buy, and thus increases the 
quantity that will be bought. It is this that is parallel 
to the effect of an increased demand for mutton in 
making it more profitable to breed sheep. But it also 
serves to increase the purchasing power with which to 
buy commodities, because it increases the aggregate 
real wealth of the community, and it thus serves to 
raise the whole demand curve. This last consideration 
is so important as to make it overwhelmingly probable, 
apart from the evidence of history, that an increase in 
the supply of capital (and the same may be said of an 
increase in the supply of the other agents of production) 
will on balance increase the demand for labor. The 
evidence of history points to the same conclusion. The 
history of the last hundred years displays an unprece- 
dented accumulation of capital, and an unprecedented 
extension of machinery, associated with an unprece- 
dented improvement in the standard of living through- 
out the whole community. This is powerful testimony 
in favor of the view that an increase in the supply of 
capital and the use of machinery will usually enhance on 
balance the demand for labor. Moreover, though this 
is not conclusive, there is little room for doubt that an 
obstructive attitude towards the extension of machinery 
in a particular country, or a particular district, is mis- 
guided. For its effect must be to make production 
more costly there than it is elsewhere, and to lead, 
slowly perhaps, but very surely, to the transference of 
the industry to other regions. 



JOINT DEMAND AND SUPPLY 79 

§ 6. Conclusions as to Joint Supply and Joint Demand. 
Here, however, we are beginning to digress. Let us 
sum up in a general form our conclusions as to the way 
in which changes in the supply or demand of a commod- 
ity react upon the demand or supply of the other things 
with which it is jointly demanded or supplied. Every- 
thing turns, as we have seen, on the possibility of 
variation in the proportions in which the things are 
used or produced together; and this, it is also clear, 
is a matter of degree. Our conclusions, therefore, had 
best take the following form: — 

Vn. When two or more things are jointly de- 
manded, in proportions which cannot easily 
be varied, the tendency will be for an increase 
(or decrease) in the supply of one of them to 
increase (or decrease) the demand for the 
others. These results will be more certain, 
and more marked, the more difficult it is to 
vary the proportions in which the things are 
used. 

Similarly, when two or more things are 
jointly supplied, in proportions which cannot 
easily be varied, the tendency will be for an 
increase (or decrease) in the demand for one 
of them to increase (or decrease) the supply 
of the others. These results again will be 
more certain and more marked, the more 
difficult it is to vary the proportions in which 
the things are supplied. 

§ 7. Composite Supply and Composite Demand. Joint 
Demand and Joint Supply do not complete the list of 



80 SUPPLY AND DEMAND 

relations between the demand and supply of different 
things. Between tea and coffee, or beef and mutton 
there is a relation of a different kind. These things are 
in large measure what we call "substitutes" for one 
another. An increased supply, and a lower price of 
mutton, will probably induce us to consume less beef. 
This relation it is convenient to describe as Cismposite 
Supply.- Beef and mutton make up a composite supply 
of meat; tea and coffee a composite supply of a certain 
type of beverage. For any group of things, between 
which the relation of Composite Supply exists, we can 
I / say, with complete^enerality, that an increased supply 
of one of them will tend to diminish the demand for 
the others. Parallel to the relation of Composite 
Supply is that of Composite Demand. There are fre- 
quently several alternative uses in which a commodity 
or service can be employed; and these alternative uses 
make up a composite demand for the thing in question. 
Thus railways, gasworks, private households and a 
great variety of industries contribute to a Composite 
Demand for coal. It is worth noting that there is fre- 
quently an association in practice between Joint De- 
mand and Composite Supply on the one hand; and be- 
tween Joint Supply and Composite Demand on the 
other. Wool and mutton, for instance, we have de- 
scribed as an instance of Joint Supply; but, in so far as 
the proportions of wool and mutton can be varied, we 
can regard these things as constituting a Composite 
Demand for sheep. And this conception may help us 
to retain a clearer and more orderly picture of the prob- 
lems we have discussed above. We can regard the fact 
that wool and mutton are produced together as their 



JOINT DEMAND AND SUPPLY 81 

Joint Supply aspect, and the fact that these proportions 
can be varied as their Composite Demand aspect; and 
the question as to whether an increased demand for 
mutton will increase the supply of wool turns upon 
whether the former aspect is more important than 
the latter. Similarly labor and machinery, employed 
together for the same purpose, form an instance of 
Joint Demand; but in so far as they can be substituted 
for one another, they constitute a Composite Supply of 
alternative agents of production. 

These four relations of Joint Demand, Joint Supply, 
Composite Demand and Composite Supply are well 
worth remembering and distinguishing from one 
another. They are of immense importance in every 
branch of economic affairs. There are hardly any 
economic problems upon which we are fitted to express 
an opinion, unless we have a lively sense of the far- 
reaching ramifications of cause and consequence, of the 
subtle and often unexpected interconnections between 
different industries and different markets. To gape at 
these complexities in a confused stupor is as foolish as 
it is to ignore them. But confusion and stupor are only 
too Hkely to represent our final state of mind, if we 
attempt to deal with these complications, one by one 
as they occur to us, in a piecemeal and haphazard 
fashion. We need a clear method, a systematic plan 
by which we may search them out, and fit them into 
place. The four relations which we have enumerated 
supply us with such a plan and method. For they 
represent something more than a series of pompous 
names for familiar notions. They constitute a classifi- 
cation of the various ways in which the demand and 



82 SUPPLY AND DEMAND 

supply of one thing can affect the demand and supply of 
others; a classification which is exhaustive when we 
add the relation of derived demand, and an analogous 
relation oh the supply side which we must now notice. 

§ 8. Ultimate Real Costs. Just as the utility of "pro- 
ducers' goods" is derived from that of the "con- 
sumers' goods" which they help to make; so the 
cost of any commodity is derived from the cost of the 
things which help to make it. Moreover, just as we 
recognize that the utility of ''consumers' goods" lies 
at the back of all demand, and constitutes the ultimate 
end of all production; so we cannot but feel, however 
obscurely, that behind the phenomena of money costs, 
there must lie certain ultimate costs, of which all money 
costs are but the measure. But when we try to explain 
what the nature of these real costs may be, we are 
plunged in difficulty. Wages, it may indeed seem at 
first sight, present no trouble. There is the effort 
and the fatigue, the unpleasantness of human labor, to 
represent real costs. But can we suppose that these 
things are measured with any approach to accuracy by 
the wages which are paid in actual fact? Is it true, 
even as a broad general rule, that the services which are 
most arduous and most disagreeable command the 
highest price? And wages are not the only ingredient 
of money costs. There are profits: to what real costs 
do profits correspond? More difficult still, to what 
does rent correspond? These plainly are not questions 
upon which he who runs may read. It will be necessary 
to devote the next four chapters to their elucidation. 



CHAPTER VI 

LAND 

§ 1. The Special Characteristics of Land. In the great 
process of co-operation by which the wants of man- 
kind are supphed, Nature is an indispensable partici- 
pant. She renders her assistance in an infinite variety 
of ways, of which the properties of the soil which 
man cultivates form only one; but the sunshine and 
rain which enable the farmer to grow his crops; the 
coal and iron ore beneath the surface of the earth, can 
be regarded for oiu' present purpose as forming part of 
the land with which they are associated. We can 
thus concentrate upon land as the representative 
of the free gifts of nature, which are of economic 
significance. Land in modern communities is for the 
most part privately owned. It can be bought and sold 
for a price, and acquired by inheritance. Moreover, it 
is a common practice, particularly in the United 
Kingdom, for an owner who does not wish himself to 
cultivate or otherwise use the land, not to sell it to the 
man who does, but to lease it to him for a term of years 
for an annual payment which we term rent. It is there- 
fore natural and convenient to envisage the problems, 
which we shall consider in this chapter, as problems 
concerning the price and rent of land. But, once again, 
the laws and principles which we shall state and 
illustrate in terms of the current systems of ownership 

83 



84 SUPPLY AND DEMAND 

and tenure, possess a much deeper significance than 
this terminology might suggest. 

The fact that land is a free gift of Nature distin- 
guishes it in various ways from commodities which 
are produced by man. The peculiarities which are most 
important from the economic standpoint are (1) that 
the supply of land is, broadly speaking, fixed and 
unalterable, and (2) that its quality and value vary, 
from piece to piece, with a variation which is immense 
in its range, but fairly continuous in its gradation. 
These are thus two aspects from which the phenomena 
of price and rent can be regarded; aspects which it is 
usual to call, (1) the scarcity aspect, (2) the differential 
aspect. 

§ 2. The Scarcity Aspect. The fact that the supply of 
land is fixed has the following significance. If the 
demand for land increases, the price will tend to rise. 
This is also true, for a short period at least, of an 
ordinary commodity. But, in the latter case, there 
would ensue an increase in supply which would serve to 
check the rise in price, and possibly, if production on a 
larger scale led to improved methods of production, 
bring the price down eventually below its original level. 
In the case of land, no such reaction is possible. There 
is nothing, therefore, to restrain the price (and the rent) 
of land from rising indefinitely, and without limit, 
if the demand for it should continue to increase. Con- 
versely, if the demand for land falls off, there is nothing 
to check the consequent fall in price and rent. In the 
case of ordinary commodities, the supply would be 
diminished, because most things are either consumed 



LAND 85 

by being used, or wear out in the course of time, and 
a regular annual production is therefore necessary to 
sustain their supply at the existing level. But land 
remains, whether it is used or not; and its supply is, 
broadly speaking, just as incapable of being diminished, 
as it is of being increased. Changes in the demand for 
land in either direction are thus likely to affect its price 
in a much greater degree than that in which the price of 
an ordinary commodity will be affected by a correspond- 
ing change in its demand. 

For most purposes, however, it is of more interest 
to compare land with other agents of production, 
especially with capital and labor, rather than with 
ordinary commodities. Now, as we have already 
noted, there is some doubt as to the manner in which 
the supply of capital or labor is likely to be affected 
by alterations in demand price. But the supply of 
capital and the supply of labor, even if we suppose 
them to be as entirely unresponsive to price changes as 
is the supply of land, are at any rate not fixed. Not 
only may they vary for many reasons, but they are in 
fact likely to vary in direct proportion to the population. 
An increase in population implies an increase in the 
supply of labor; and it is likely to be accompanied 
by an increase in the supply of capital; in other words, 
the supply of these agents will expand, as the demand 
for them expands. But the supply of land will remain 
what it was. This fact is enormously important in 
connection with the broad problem of population, which 
will form the theme of Volume VI. 

But it is important also in other connections. It has 
been the dominating factor in many absorbing con- 



86 SUPPLY AND DEMAND 

troversies upon high poHcy regarding the ownership of 
land, or the taxation of land values, upon which we 
can touch but lightly here. It has seemed to many 
writers a reasonable proposition to lay down, that the 
ordinary course of the progress of society, the increase 
of population and industry, must mean, as a broad 
general rule, a constant increase in the demand for land. 
And, if that be granted, it seenxs to follow that the 
price and rent of land will tend constantly to increase. 
John Stuart Mill, accordingly, in the middle of the last 
century, asserted that "the ordinary progress of a 
society, which increases in wealth, is at all times tending 
to augment the incomes of landlords; to give them 
both a greater amount and a greater proportion of the 
wealth of the community, independently of any trouble 
or outlay, incurred by themselves," ^ and upon the 
strength of this assertion, he justified the policy 
of imposing a special tax upon what we have come 
to call the "unearned increment" of land. But how 
far does actual experience bear his assertion out? 
In Great Britain we have seen in the last half-century 
an undoubted increase in urban rents; but over long 
periods at least, there was a marked fall in both the 
prices and rents of agricultural land, despite the 
fact that the country was "increasing in wealth" 
as rapidly as ever before. This was due, of course, in 
the main to the increased supplies of wheat and other 
foodstuffs coming from the New World: and if, accord- 
ingly, we choose to lump together not only our own 
urban and agricultural land, but the land of other 
countries as well, and to speak vaguely of the demand 
* Principles of Political Economy, by John Stuart Mill. 



LAND 87 

for land as a whole, it might seem as though we could 
argue that Mill's generalization still holds good. But 
even this is by no means certain and in any case such 
a generalization is of very little service: what the 
illustration should rather suggest to us, is the danger 
of speaking of land vaguely as a whole, and the impor- 
tance of turning our attention to the variations in value 
between different kinds and different pieces. 

§ 3. The Differential Aspect. Most ordinary commodi- 
ties are not produced on a single, uniform pattern. As a 
rule there are many variations of grade and quality, 
and consequently of price. But these variations are 
usually designed to meet the differences of taste among 
the purchasers, and we do not expect to find that any 
variety of an ordinary commodity will be produced, 
which is so poor in quality as to be entirely valueless. 
But since it is nature which has produced the land, 
without any assistance or guidance from man, there are 
many pieces of land which are so unfertile, or are other- 
wise so unsuitable for productive purposes, as to be 
quite valueless from the economic standpoint. Even 
in a densely populated country like Great Britain, there 
are considerable tracts of land which it is unprofitable 
to employ for any economic purpose whatsoever, and 
which possess no further value than what the mere 
pride of ownership may give them. This fact makes it 
possible to apply the conception of the margin to the 
case of land with particularly illuminating results. 

In the first place, however, it should be observed 
that the value of any piece of land does not depend 
solely on the intrinsic fertility of the soil. The fact that 



88 SUPPLY AND DEMAND 

land is an immobile thing makes its situation a factor of 
great importance. In the case of urban land, situation 
is, of course, the only thing that counts. The value of 
a site in Bond Street or the City is entirely unaffected 
by its capacity or incapacity for potato-growing 
purposes. But even for agricultural land, situation is a 
most important matter. A farm, which is so remote 
that considerable transport charges must be incurred 
to bring its produce to market, will be less sought after, 
and less valuable, than one which is much better 
situated though somewhat less fertile. In what follows, 
therefore, we must speak of the '' quality" of a piece 
of land in a broad sense to include advantages of 
situation, as well as of fertility. Let us now, imagine 
the different pieces of land in Great Britain to be 
arranged in order of quality, so that we have a long 
series, with land of the best quality at one end, and of 
the poorest quality at the other. At the latter end, we 
will have such land as is found near the top of Snowden 
or Ben Nevis, which it clearly does not pay to cultivate 
at all. Somewhere, then, between these two extremes, 
we shall come to a point where the land is just, but only 
just, worth cultivating, or where, to revert to a form 
of words we previously employed, it is a matter of douhtj 
whether the land is really worth using for a productive 
purpose. Such land we can regard as the "marginal 
land"; and since the variety of nature is at once 
infinite and fairly minutely graduated we shall probably 
find that on one side of this margin there is much land 
which is only slightly superior, and on the other, much 
which is only slightly inferior, to the marginal land 
itself. What, then, is likely to be the value and the 



LAND 89 

rent of this marginal land, this land which is just on the 
"margin of cultivation"? Some readers may find the 
answer startling. The rent of the marginal land will 
be nil, because it will not pay to cultivate it, if any 
appreciable rent is charged. A piece of land for which 
it is worth a tenant's while to pay an appreciable rent, 
will not be the marginal land, because there will be land 
just slightly inferior to it which it will also pay to 
cultivate if a somewhat lower rent is charged. And so 
we can pass to poorer and poorer qualities of land, 
with an ever diminishing rent, until at the margin of 
cultivation the derived utility of the land is negligible 
and the rent vanishes. 

This certainly is a somewhat abstract conception; 
but it is by no means so remote from reality as may at 
first sight appear. The reader may protest that in the 
course of an extensive and varied acquaintance with 
landowners, he has not yet run across this peculiar 
marginal type, who lets his land for no rent at all. But 
there, if his experience is really extensive, I think he 
is mistaken. It so happens that the ordinary agricul- 
tural landowner leases out his land, not by itself, but 
together with a variety of other things such as farm 
buildings, which it costs him a considerable sum of 
money to provide. He will not as a rule be willing to 
go to this expense, unless he sees his way to obtain for 
the farm an annual payment, which represents at least 
a fair return on this capital outlay, as big a return as 
he could have got, for instance, by investing the 
same amount of money in some gilt-edged security. 
This annual payment will, it is true, be called rent; 
but the significance of this is that what we term rent 



90 SUPPLY AND DEMAND 

in ordinary life is usually a complex thing, made up of 
two essentially distinct elements, viz. the normal return 
on the capital goods supplied together with the land, 
and what we may call the ''net rent,'' or the "pm*e 
rent" attributable to the land itself. Now will any 
reader make so bold as to say that there is no land under 
cultivation, in respect of which this net rent is either nil 
or negligible? The landowners will not agree with him. 
It is not a question, it should be observed, as to whether 
the rent obtained represents more than a fair return on 
the purchase price paid for the land; that is quite another 
matter. The question is whether the rent obtained 
exceeds a fair return on the capital sum spent on the 
buildings, etc. ; with which every farm must be equipped 
to let at all. In fact there are not a few farms where 
there is no such excess, and where accordingly there 
is no "net rent" or " pure rent" which can be attributed 
to the land. 

The question whether it would be profitable to cul- 
tivate any piece of land, turns upon whether the re- 
ceipts which would be obtained by selling the produce 
would exceed the costs of cultivation: and under these 
costs of cultivation we must include, of course, the 
remuneration of the farmer's services. Farmers, Kke 
other people, have to live; and they would not take 
on the troublesome job of farming, unless there seemed 
a prospect of making a living out of it. The remu- 
neration of the farmer takes, of course, the form not 
of a salary, but of profits: and these profits vary very 
much from year to year, and from place to place, and 
from man to man. But they are essentially payment 
for work done, and an ordinary profit must be regarded 



LAND 91 

therefore as part of the necessary costs of farming. 
Thus it will not be worth while to cultivate a piece 
of land, and the land will in fact lie unused, upon 
which a careful farmer might obtain a profit in the 
ordinary sense, of no more than $50 or |100 a year. 
The marginal land will be land which yields a decent 
profit to a decent farmer, as well as a gross rent to the 
landowner, sufficient to compensate him for his capital 
outlay, but nothing further. 

What, then, will be the rent of a fertile and well- 
situated farm, about which there is no doubt that it is 
well worth cultivating? Part of the gross rent which 
the landowner receives must again be regarded as 
merely a return for the capital expended in equipping 
the farm for use; but in this case, there will be a residue 
left over, which constitutes the net rent of the land. 
The net rent will measure the derived utility of the 
land to its occupier, and will in general represent 
(very roughly, of course, in practice) the differential 
advantage of cultivating the land in question rather 
than land on the "margin of cultivation." This differ- 
ential advantage may take either, or both, of the forms, 
of a larger produce per acre, or a lower cost of produc- 
tion and marketing. But, in any case, the extra profit, 
which, if no rent were charged, a decent farmer could 
obtain by cultivating the farm in question, rather than 
a marginal farm, will be roughly equal to the net rent 
which his landlord can exact from him, if his landlord 
so chooses. The landlord may, of course, not choose 
to exact a rent as high as this; and as a matter of fact, 
in a country like Great Britain landlords often con- 
tent themselves with less. The traditions associated 



92 SUPPLY AND DEMAND 

with the ownership of agricultural land, and with the 
relations between landlord and tenant serve to soften 
the edge of economic law, and to subject the rents 
which are actually fixed to the control in no small 
measure of the general sense of what is fair or cus- 
tomary. In such cases the landlord makes the farmer 
a present, for the time being, of part of the economic 
rent. On the other hand, as Irish agrarian history 
well illustrates, the landlord may sometimes expro- 
priate under the name of rent, permanent improvements 
which are due to the labors or the expenditure of the 
tenant. This is, of course, particularly likety to happen, 
whenever it is the custom to leave to the tenant the 
obligation of providing the capital equipment of the 
farm, which in Great Britain is, for the most part, the 
recognized duty of the owner. Again, in the case of 
urban land in the South of England, expropriations 
of this kind are an essential and well-understood fea- 
ture of the leasehold system. The owner grants a 
lease for a long period of time, usually ninety-nine 
years, for a ground rent, which is notoriously below 
the true economic rent of the land, subject to the 
condition that the leaseholder must erect upon the 
land and keep in good repair certain buildings, which 
on expiry of the lease will become the property of the 
ground owner. Here the nominal ground rent is only 
part of the total rent which is really paid; the ultimate 
transference of the buildings representing often the 
more important part. There is, in fact, a great variety 
of systems of land tenure, some of which are highly 
complex, the respective merits of which vary greatly, 
and which constitute a most important problem for 



LAND 93 

statesmen and legislators. Considerations of this kind 
in no way diminish the importance of the general 
analysis of rent, which we are pursuing in the present 
chapter. Rather they make it the more important, 
because we cannot properly weigh the merits of any 
system of land tenure, until we have grasped clearly 
the principles governing the rent of land in the purest 
form. But certainly we must never forget that the rent 
we are discussing may differ very greatly from, though 
it will vitally influence, the money payments which 
are called rent in actual life. It is the pure economic 
rent, the rent which represents the full annual pay- 
ment which it would be worth pajdng to obtain the use 
of the land alone, which will measure, as we have said, 
the differential advantage of the land in question 
over land on the margin of cultivation. 

A clear grasp of this relation helps us to perceive 
that an increase in the prosperity of the community may 
sometimes influence rents in an unexpected way. It 
all depends on the causes which have given rise to 
the increased prosperity. An advance, for instance, 
in agricultural science will facihtate a more abundant 
supply of foodstuffs; but it will not necessarily in- 
crease the aggregate rents of agricultural land. For if 
it takes the form, say, of the discovery of some new 
artificial manure, it will very likely facihtate production 
on the less fertile soils far more than it will on the more 
fertile soils where artificial manures are not so neces- 
sary. It will thus tend to diminish the differential 
advantages of working on the more fertile farms, and 
their rents will accordingly fall, possibly by much more 
in the aggregate than any increase in the rents of the 



94 SUPPLY AND DEMAND 

farms near the margin of cultivation. The point may, 
perhaps, be better understood if we pass from agricul- 
tural to urban land, and ask what would be the effect 
on site values of a great improvement in the facilities 
of internal transport. Push the case to an extreme, and 
suppose passenger transport to become so cheap and 
so quick that there ceases to be any advantage in 
living in a town so as to be near your place of work. 
Urban landlords would no longer be able to obtain the 
high rents they now receive for the sites of houses 
in or near a town. For most people would prefer to 
move out into the country where sites can be obtained 
at little more than an agricultural rent. The country 
covers so large an area relatively to the towns that 
the supply of rural sites would be still very plentiful as 
compared with the demand. Their rents would not, 
therefore, rise by very much, although the rents of the 
housing sites in towns would fall heavily. Of course, 
there are other factors to be taken into account before 
we could pronounce upon the effect on aggregate rents. 
Central sites for shops might, for instance, fetch a 
higher rental than before. The purpose of this discus- 
sion is not to generalize but to show the danger of gen- 
eralizing about rents in the aggregate, or land as a whole. 

§ 4. The Margin of Transference. The last illustration 
may serve, however, to remind us of an obvious fact 
which we must now take into account. The same 
piece of land may be used for a variety of purposes. 
It may have been used for growing corn, and later it 
may be devoted to the building of houses, or, as at 
Slough, to a repair depot for motor vehicles. It need 



LAND 95 

hardly be said that the land will, as a general rule, 
be put to the use in which its value is greatest; or to 
speak more strictly, in which the biggest rent, or the 
biggest selling price can be obtained. But the notion 
of the differential advantages which a piece of land 
possesses over the marginal land becomes decidedly 
more complicated when we take account of this variety 
of uses. Let us turn our attention, for instance, to the 
sites used for shop and office purposes, and consider 
what we can regard as the marginal site in this connec- 
tion. Clearly it will not be the marginal land of which 
we spoke above, which it only just paid to cultivate, 
and which yielded no rent at all. For this will prob- 
ably be agricultural land in an out-of-the-way dis- 
trict, where no one would dream of setting up an office 
or a shop. Any site upon which a sane man would con- 
template setting up a shop will certainly possess value 
for other purposes, such as house-building. Hence the 
marginal site for shopkeeping purposes will not be like 
our marginal farm, a site which yields no rent. 

As regards many pieces of land, there is no doubt 
as to the purposes for which they can most profitably 
be used. This piece will command a much higher rent 
as a shop site than in any other capacity; for that piece 
house-building is the obvious employment; for another, 
agriculture. But in quite a number of instances there 
is considerable imcertainty. It is not clear whether 
upon this site it will be better to erect a house or a shop, 
or if the latter, what kind of a shop. It is not clear 
whether it will pay to use that farm land for a building 
scheme; and, within the domain of agriculture, which 
of course comprises an immense variety of really dif- 



96 SUPPLY AND DEMAND 

ferent industries, it is often a very moot point indeed 
whether a certain field should be left under grass, or 
brought under the plow. Cases of this sort are not phan- 
toms of the imagination; they emerge on every side as 
concrete problems with which some one or other is deal- 
ing every day, and it is these cases which constitute the 
marginal land for the purposes of a particular occupa- 
tion. The marginal sites for shops are the sites for which 
it is only just worth while to pay rents sufficient to entice 
them away from houses. And the rent for a site in Bond 
Street, or elsewhere, which is so much more suitable for 
shop purposes that no alternative use would be worth 
considering, will exceed the rent paid for one of these 
marginal sites by, roughly speaking, the extra advan- 
tage it possesses for shop purposes. Or will fall short of 
it, it may be well to add, to the extent of its comparative 
disadvantage. For there may be many such marginal 
sites, some of which will fetch low rents, and others 
very high rents indeed; the same site being often of 
great potential utility for a large variety of occupa- 
tions. Between any two occupations there will thus 
usually be a margin of transference, which we must con- 
ceive not as a point, but as an irregular line, upon or 
near to which there will be many pieces of land, differ- 
ing greatly in the rents which they fetch. These varia- 
tions of rent will correspond to the differences between 
the advantages or derived utilities which the sites 
possess for both the occupations in question. The 
position of such margins of transference will of course 
alter as industrial conditions change, and, when they 
alter, the rents of sites which are not near any margin 
of transference will be affected also. Thus an increased 



LAND 97 

demand for the products of any particular industry 
will make it profitable for that industry to offer higher 
rents, and thus draw land away from other occupa- 
tions. This will have the effect of raising, though 
possibly to a very slight extent, the rents of sites which 
still remain in other uses; for there will be fewer of 
them available; and their derived utilities will con- 
sequently be increased. 

But here, as everywhere, it is upon the margin that 
our attention should be focussed, because it is round 
about the margin (wherever it is found) that the 
changes are taking place which really matter for society. 
When Mr. Mallaby-Deeley buys an estate in Covent 
Garden from the Duke of Bedford, the transaction 
hardly deserves the degree of public interest it excites. 
Nothing has happened which is of material consequence 
to anyone except the two gentlemen concerned; the 
various sites are still used for the various purposes for 
which they were used before; nothing has occurred 
that really matters. But when houses are pulled down 
for the erection of a cinema, or when a field is diverted 
from tillage to pasture, something has happened which 
affects for good or ill the interests of the whole com- 
munity. Conversion from tillage to pasture represents, 
indeed, a tendency which has been very marked in 
Great Britain during the last generation, and has 
aroused misgivings in many public-spirited observers. 
Possibly for a variety of reasons, these misgivings may 
be justified; certainly the problem is well worthy of 
attention. But when in this way the issue is raised of 
tillage versus pasture, it is essential, if we are to dis- 
cuss it rationally, that we should envisage it clearly 



98 SUPPLY AND DEMAND 

as applying only to a limited portion of agricultural 
land, to the portion which lies somewhere near the 
margin of transference, as things are now, between 
the two forms of agriculture. It might be socially 
desirable to bring under the plow a field which the 
farmer finds it only slightly more profitable to lease 
under grass; but this would be highly improbable 
in the case of a field where the balance of argument 
to the farmer in favor of pasture is overwhelming. 
The position of the margin of transference between 
different uses may, in other words, be somewhat out of 
place from the social point of view, and it may be 
desirable by appeals and propaganda, even conceiv- 
ably by the devices of State subsidy and compulsion, 
to push it forwards or backwards in greater or less 
degree. But it will be necessarily a matter of degree, 
and nothing could be more foolish than to speak as 
though there was, or could be, some ideal method of 
cultivation equally applicable to all lands, without 
regard to their climatic and other conditions. Needless 
to say, none of the agricultural experts who sometimes 
deplore the decline of arable farming are guilty of such 
foolishness. But the sense of the diversity of nature 
which is very vivid to them may sometimes be lacking in 
people who live in towns, and a firm grasp of the mar- 
ginal notion may serve best to keep the latter from 
forgetting it. 

§ 5. The Necessity of Rent Behind all such detailed 
applications there lies a more general consideration 
which deserves attention. The way in which the land 
of a country is used, the way in which it is apportioned 



LAND 99 

between the countless alternative employments that are 
possible, is a most important matter, more important 
perhaps than any questions as to the size of the incomes 
which particular landowners receive by virtue of their 
rights of ownership. How is this apportionment 
effected as things are now? The answer is clear: mainly 
by the agency of either rent or price. The business 
which finds it worth while to offer the highest rent or the 
highest price for any piece of land will, as a rule, be 
able to command its use. And, with this as the govern- 
ing principle, an apportionment is secured between 
shops, offices, factories, agriculture, between the im- 
mense variety of different employments covered by 
each of these broad headings; not a rigid unvarying 
apportionment, but one which constantly changes as 
economic circumstances change, and as the margin of 
transference between different occupations moves hither 
and thither. This apportionment takes place at present 
as the result of the independent decisions and bargains 
of many private individuals, who are thinking mainly of 
their own interests, and not of those of the community. 
But this state of affairs might be altered. The land 
might be nationalized and allocated to its various uses 
by the co-ordinated labors of a great State department, 
or some other agency of the collective will. However 
improbable such a change, it is perfectly conceivable. 
But what is not conceivable is that any State depart- 
ment should handle the job with a success even ap- 
proaching that of the present system, unless it con- 
tinued to use, as its main instrument, the criterion of 
either rent or price. That a piece of land would yield a 
higher rent in one occupation than in any other is not 



100 SUPPLY AND DEMAND 

conclusive evidence that it is best to devote it to the 
former purpose, but it is very good evidence, and it 
should be allowed to prevail unless it is demonstrably 
outweighed, as it possibly might often be, by considera- 
tions of a different kind. That it would not be well for 
the community to employ land in the city of London for 
corn-growing purposes, however desirable might be a 
revival of home agriculture, is so obvious that it 
may seem to have no bearing on the present issue. 
But it is only an extreme indication of the absurd 
and wasteful use of our natural resources, which would 
grow up slowly but surely, if we dispensed with ideas of 
rent and price as sordid irrelevancies, and allocated 
our land on the basis of a balancing of the loftiest 
arguments of a vague and sentimental character. If 
you are prepared for the distribution of land to become 
stereotyped, for each piece to continue indefinitely 
in its present use, then indeed you might dispense with 
rent, as primitive societies very largely do. That would 
mean stagnation and, for an industrial country, decay. 
But if changes are ever to be contemplated, a simple 
quantitative measure is the only safeguard against utter 
chaos. Thus rent, like interest, will be found indispen- 
sable as a measure under any efficient system of society, 
even if it might not always represent the payment of 
sums of money to private individuals. And that is why 
the principles governing rent possess, as I indicated at 
the outset of this chapter, an importance more funda- 
mental than our present system of ownership and tenure. 

§ 6. The Question of Real Costs. But we must not 
forget the prehminary question that started us upon 



LAND 101 

our analysis of the agents of production. The rent 
which a manufacturer or farmer has to pay for his land 
he naturally includes in his cost of production. But 
does this money cost to the individual correspond 
to, and measure, any real cost to the community as a 
whole? Here let us note in the first place that if only 
we could disregard the variety of uses to which land is 
put, if we could suppose that all industry was agricul- 
ture, and that agriculture was a single industry with a 
single product, we could argue that rent does not enter 
into marginal costs at all. For we could regard the 
marginal producer as the one working on a marginal 
farm, whereas we have seen there is no pure rent. The 
rent which other producers have to pay would thus 
represent merely the destination of the surplus profits 
which arise wherever actual costs fall short of marginal 
costs. This way of looking at the matter has proved 
attractive to some thinkers, not in the least because of a 
desire to paUiate the effects of landlordism, but because 
it fits in so well with our general sense of rent as a 
*^ surplus," and a surplus as something distinct from a 
necessary price. But it is clearly illegitimate in an 
economic theory which professes 'Ho describe the 
facts." The marginal land for many purposes fetches, 
as we have seen, a considerable rent; and this rent is 
certainly part of the marginal costs and of the necessary 
price of the products of the particular industry. The 
answer to our question is, however, not now very diffi- 
cult to see. Land, greatly as it differs in many respects 
from the other agents of production, resembles them in 
the very important respect that, being used for one 
purpose, it is not available for other purposes, and that 



102 SUPPLY AND DEMAND 

the productive powers of the community in other direc- 
tions are thereby diminished. This is the real cost to 
the community, which attaches to the products of any 
industry, in virtue of the land which it occupies; 
not any human labors or sacrifices required to produce 
the land itself, but the curtailment of the natural 
resources available for productive use elsewhere. This 
is the real cost of which rent is the money measure, 
and generally speaking an accurate measure at the 
margin of transference between one occupation and 
another. A somewhat fanciful use of the term cost, 
this may seem perhaps, one not quite in accordance 
w^ith our instinctive sense of what real costs should be. 
But possibly the real costs represented by wages and 
profits may turn out to be not so very different, and 
we had best leave the matter there, until we have 
examined the nature of these other costs. 

§ 7. Rent and Selling Price, In this chapter we have 
spoken mainly of the rent rather than the price of land : 
the relation between the two things is fairly obvious 
and well understood, but it will be well not to close 
the chapter without a brief account of it. The price of 
any piece of land is affected by all the considerations on 
which its rent depends, but it is also affected by another 
factor which has no influence whatever upon rent. 
This factor is the rate of interest. The higher the rate 
of interest, the higher the return which a man could 
obtain by buying gilt-edged securities, the lower will 
be the price that he will pay for a piece of land which 
yields a given rent. We can express the relation more 

precisely by the formula Price - gg;|^gL-^,though 



LAND 103 

we must be careful, in applying this formula in practice 
to allow for the possible deviations between the nominal 
and the true rent, and similar complications. The 
price, it must be observed, is derived in this way from 
the rent, not the rent from the price. ^ Rent is thus 
logically the simpler, price the more complex thing. 
It is well, therefore, to analyze in the first instance the 
principles of rent, if we live in a country where the 
practice of leasing land for annual rent is less common 
than it is in Great Britain, even if, for whatever reason, 
it is the price of land with which we are concerned in 
practice. The problem of price contains two distinct 
elements which it is not easy to handle when mixed up 
together. For the rate of interest represents in itself 
an important branch of economics, which will require 
a separate chapter to itself. 

1 In this the rent of land differs fundamentally from that of 
other things, such as houses. For the price of a house is largely 
influenced by the costs of construction of new houses, and should 
correspond closely to them in the long run. The same relation 
between rent, price and rate of interest will hold good; but the 
rents will be affected by changes in the rate of interest, owing to 
the reactions of such changes on the supply of houses. 



CHAPTER VII 

RISK-BEARING AND ENTERPRISE 

§ 1. Profits and Earnings of Management. The profits 
of a business, as they are ordinarily reckoned, whether 
for the purposes of income tax or of a balance sheet, 
comprise several elements which are fundamentally 
distinct. The relative importance of these various 
elements varies greatly from one type of business to 
another. The profits of a private business include, for 
instance, the remuneration of the work of management, 
which in the case of a Joint Stock Company is mostly 
paid for by salaries or directors' fees. It is to their profit 
that farmers, small shopkeepers, and the partners of 
a private firm look not merely for a return upon their 
capital, but for the reward of their own labors. " Earn- 
ings of Management," as they are usually termed 
(though in truth they often cover other and humbler 
forms of labor) are thus frequently one of the ingredi- 
ents of profits. 

§ 2. The Payment for Risk-hearing. There is another 
element of great importance about which our ordinary 
ideas are apt to be so vague that it will be well to devote 
a chapter to its examination. This is the element of 
payment for risk, or rather the reward of risk-bearing. 
Risk is inherent in all business, as it is inherent in all 
life. The vagaries of nature and the vagaries of man 

104 



RISK-BEARING AND ENTERPRISE 105 

are alike responsible. The farmer may find his harvest 
ruined by a drought or by a deluge; the coal or the gold, 
for the extraction of which you have perhaps set up 
an extensive mining plant, may come to an end which 
is unexpectedly abrupt. You may put your money 
into roller-skating rinks and find that cinemas have 
become the rage with the fickle public; sometimes 
"the market" may decHne for causes which remain 
obscure but with consequences which are disagreeably 
plain. But while risk is always present in some degree, 
the degree varies enormously from one industry to 
another. Now, it is obvious enough that in an excep- 
tionally risky industry, where there is a considerable 
possibility that the capital invested will yield no return 
at all, the profits of those concerns which succeed 
are likely to exceed the rate of interest on gilt-edged 
securities. But what is likely to be the magnitude of 
this excess? Is risk-taking rewarded if there is any such 
excess, however small? Or will it suffice that the gains 
and losses should average out to a fair rate of interest 
over the whole industry? To enable us to think closely 
let us suppose for a moment that we can measure 
accurately what the chances are. 

Suppose, then, that there were a precisely equal 
chance of success on the one hand and failure on the 
other in any enterprise, failure involving a complete 
loss of all the capital invested. Suppose, further, 
6 per cent to be at the time a fair return on a perfectly 
secure investment. What would be the return which 
must be expected from the risky enterprise, in the 
event of its succeeding, before it will be undertaken? 
The reader may be tempted to answer, 12 per cent. 



106 SUPPLY AND DEMAND 

But 12 per cent would not suffice. An equal chance 
of 12 per cent or nothing, as compared with a certainty 
of 6 per cent, does not mean that the risk in the former 
case is paid for to the tune of 6 per cent. It means 
that it is not paid for at all. In each case what a 
mathematician would call the expectation is a return 
of 6 per cent. The odds are evenly balanced; in the 
long run, over a large number of cases, if the law of 
averages works as we assume it does, you would get 
just as much from the one type of investment as the 
other. Now, risky enterprises will not, as a rule, be 
undertaken on terms like these; investors and business 
men will not take risks with the odds precisely equal; 
they must have them, or believe that they have them, 
in their favor. 

§ 3. Monte Carlo and Insurance. To assert this is not 
to ignore the strength of the appeal which the gambling 
instinct makes to many, if not to most of us. The 
taste for gambling is, indeed, so deep and widespread 
that it would be foolish to leave it out of account in this 
connection. It is clear enough that at places like Monte 
Carlo people are prepared to have the odds unmistak- 
ably against them, apparently for the sheer pleasure 
and exhilaration of taking risks. Moreover, though for 
most people play at Monte Carlo represents a mere 
holiday indulgence, it would be unsafe to assume that 
what appeals to them there will not also appeal to them 
in their business affairs. But what exactly is the secret 
of the charm of Monte Carlo? It is the great attractive 
force of a small chance of a large gain, as compared 
with the deterrent force of a large chance of a small loss. 



RISK-BEARING AND ENTERPRISE 107 

People will readily pay $5 for one chance in a hundred 
of making no more, perhaps, than $400 or $450. And it 
is very likely that this holds good in the world of busi- 
ness. If, for example, we were to suppose that the pro- 
moters of a new enterprise were confronted with one 
chance in fifty of a profit of 50 per cent per annum on 
their capital, as against forty-nine chances of a profit of 
5 per cent, this might well prove a more attractive pros- 
pect than a certain return of 6 per cent, although the 
strict expectation of profit would be smaller in the former 
case. But the risks of business enterprise are not 
often of this type. They conform more usually to 
the opposite type of a large chance of a relatively 
small gain, balanced by a small chance of serious 
loss or entire failure. Now for almost everyone the 
possibility of a great loss will count as a deterrent 
(just as the possibility of a great gain may count as 
an attraction) for much more than its strict actuarial 
value.. 

The truth of this proposition is demonstrated by the 
existence of institutions more impressive than Monte 
Carlo — ^the Insurance Companies, which play so large 
a part in the economic life of modern times. Every 
year, and upon an ever-growing scale, both private 
individuals and business concerns pay sums of money, 
which reach in the aggregate a colossal sum, as pre- 
miums to insure themselves against loss by Fire, 
Shipwreck, Burglary, Death, Death Duties, against 
every risk which Insurance Companies will cover. 
Now Insurance Companies are not, as we say, in 
business for their health. They find their business 
profitable, and pay good dividends to their shareholders. 



108 SUPPLY AND DEMAND 

Moreover, they incur a considerable expenditure on 
offices, on clerical staff, on agents, and the like. All 
these payments must be defrayed out of the premiums 
they receive; so that it is plain that the premiums 
greatly exceed the expectation of the risks insured. 
The odds are heavily in favor of the Insurance Com- 
pany — of that the stupidest person can have no shadow 
of doubt. Yet we continue to insure, as private indi- 
viduals and as business men, and so far from being 
ashamed of our proceedings as a weak and nerveless 
folly, which somehow we are unable to resist, we blazon 
them forth in the strong accents of conscious pride. 
We preach insurance to our neighbors as the core of 
self-regarding duty, and, if ever we feel a twinge of 
uneasiness, it is lest we, too, may have omitted in some 
particular to practice what we preach. 

The significance of this is unmistakable. Be our 
psychology what it may, however deep and irre- 
pressible our taste for derring-do, however inadequate 
the scope which the dull routine of modern life affords 
for our adventurous impulses, we are most of us anxious 
to avoid the risk of great financial loss. We are very 
glad to find someone to take it off our shoulders if we 
can; so glad that we are prepared to pay him for the 
service, to pay him a sum which covers not only the 
actuarial equivalent of the risk, but something sub- 
stantial over and above. In this we are entirely ra- 
tional. Our conduct is justified by the law of the dimin- 
ishing utility of money, which was noted at the end of 
Chapter III. It would be plainly foolish, for instance, 
to substitute for the certainty of an income of f 2500 
per annum an even chance of $5000 or nothing, since 



RISK-BEARING AND ENTERPRISE lOd 

the utility to us of $5000 is not twice as great as that 
of $2500. 

The majority of business risks are not of a kind 
against which it is possible to insure. Insurance com- 
panies confine themselves to risks which are mainly a 
matter of what we call objective rather than subjective 
chance, i. e. risks in respect of which knowledge of de- 
tailed facts peculiar to the individual case is of minor 
importance. But such knowledge is of paramount im- 
portance in the case of ordinary business risks. If, for 
example, a new enterprise is to be undertaken, the spe- 
cial knowledge and experience which its promoters 
possess is a vital factor in determining their estimate of 
the risk involved. An outsider with no special knowl- 
edge would necessarily require to estimate the risk far 
more highly if we were to form a rational opinion on the 
basis of his knowledge. So great, indeed, would be the 
risk to him, that we can lay it down as a sound maxim 
that people are extremely rash who invest their money 
in risky undertakings about which they know very 
little. This subjective aspect of business risk has a 
significance to which it will be necessary to revert. 

But, though most business risks are not and cannot 
be a matter for premiums and policies, the principle, 
which the practice of insurance illustrates, applies none 
the less. In the light of their knowledge and experience, 
the promoters of a new undertaking must weigh up 
the chances of failure and success, though they will not 
do so by the precise methods of an actuary. They will 
require that any chances of serious loss should be 
balanced by such chances of exceptional gain, as would 
raise the expectation of profit well above the normal 



110 SUPPLY AND DEMAND 

return on secure investments. The more risky the 
project seems the greater, generally speaking, must 
be the expectation of profit required to induce people 
to undertake it. 

If we suppose business men to calculate reasonably, 
it follows that the average profits in any industry over 
a long period of years, reckoning in the losses of the 
concerns which disappear altogether, are likely to be 
higher, the more- risky is the industry. Such a result 
will not, of course, occur in every case. Even when the 
calculations are reasonable, they may be entirely falsi- 
fied by the event. Moreover, business men may not 
calculate reasonably on the information which they 
have. But, unless y^q suppose their judgment to be sub- 
ject to a prevailing bias in one direction, i. e. to be un- 
duly optimistic as a general rule, we should expect, and 
in any case they must expect, profits above the ordinary 
in a risky industry. 

This conclusion is sufficiently important. Far too 
many people, though they admit it when it is expressly 
stated and dismiss it even as a tiresome commonplace, 
are apt to neglect it when the occasion for applying 
it arises. For example, the great importance to any 
industry of good management is generally recognized, 
and the consequent desirability of paying adequate 
salaries to the managerial staff. The importance 
of securing a supply of capital is very widely recog- 
nized, and the practical necessity of paying a fair rate 
of interest is thus, however grudgingly, conceded. 
But the "residuary profits," as they are called, which 
accrue at present to the owners of a business, are de- 
nounced in some quarters in a sweeping fashion, 



RISK-BEARING AND ENTERPRISE 111 

which seems to ignore altogether the all-pervading 
element of risk. People speak as though you might 
appropriately limit profits in every industry to some 
uniform percentage on the capital employed, with- 
out making it clear whether you would even be allowed 
to make up in good years for the losses incurred in 
bad. The effect of introducing any such crude device 
into our present industrial system could only be to 
paralyze enterprises of an unusually risky kind, which, 
so far from being pushed to an excess at present, 
are more probably curtailed unduly from the stand- 
point of what is socially desirable. Like the fixing of a 
low maximum price for a commodity it would cause the 
supply to wither up and disappear. 

§ 4. Risk under Large-scale Organization. While this 
is true of the present economic system, the question 
is worth considering whether it represents a fundamen- 
tal necessity, whether, for instance, under our world 
socialist commonwealth the factor of risk-bearing need 
play so important a part as it does in the actual business 
world. This question cannot be answered with a 
conclusive simplicity; opposing considerations present 
themselves, between which it is not easy to strike a 
balance. On the one hand, in accordance with the law 
of averages gains and losses tend to cancel out over a 
large series of transactions, when reasonable calculations 
have been made. Thus Insurance Companies, while 
they take heavy risks off the shoulders of poUcy-holders, 
incur relatively trifling risks themselves; they can 
predict the aggregate sums which they will be called 
upon to pay within a small margin of error. In the 



112 SUPPLY AND DEMAND 

same way it might seem that every enlargement of the 
scale of business would make for an automatic insurance 
and a consequent economy of risk; and thus that if all 
businesses were comprised in a single financial unit, 
gains and losses would cancel out over so wide a range 
that the degree of risk remaining would be almost 
negligible. 

This might indeed happen, if business risks were 
mainly of that objective kind in which the insurance 
companies specialize; for then we could assume that the 
chances of success or failure would be estimated reason- 
ably. But, in fact, most business risks, not being of this 
kiad, must be estimated by processes of human judg- 
ment, which are very fallible. And here we must take 
account of the law of averages in another aspect, 
with a different bearing on the argument. When an 
industry comprises a large number of separate concerns, 
and the decisions accordingly are taken by many men, 
acting independently of one another, the errors of 
calculation will tend to some extent to cancel one 
another out. The undue optimism of one man will be 
balanced by the undue pessimism of another; and, if 
there is no prevailing bias in either direction, the errors 
of judgment will not affect the results for the industry as 
a whole. But where the effective decisions are taken 
by very few men, the chances are far greater of a pre- 
ponderating balance of error in one direction. The 
risks dependent on the factor of human judgment tend 
therefore to increase. 

This truth can be illustrated by a phenomenon which 
is fairly familiar. It is recognized by intelHgent persons 
that the risks of speculation in a particular commodity 



RISK-BEARING AND ENTERPRISE 113 

market or stock market increase more than propor- 
tionately to the scale of operations. A man who sets 
out as a *'bull" upon a small scale can buy without 
sending up the price against him in the process, and, if 
he decides later that his judgment is mistaken, he can 
at any time cut his losses and sell out without much 
difficulty. But a "bull" on a very large scale cannot 
complete his purchases except at a price which has been 
raised in consequence of his own action, and he cannot 
count on being able to "unload'^ at or near the market 
price, should he decide to do so. If, accordingly, he 
miscalculates, he cannot save himself from serious loss 
as a smaller man might do by a prompt discovery of 
his error. His difficulties spring from the fundamental 
fact that the effects of his calculations are too great to 
be offset by those of the different, and often opposite, 
calculations of other men. 

Upon the issue whether a growth in the size of the 
business unit is likely to diminish risk, the law of 
averages thus cuts both ways. The risks arising from 
the element of pure chance are more likely, those arising 
from miscalculation are less likely, to cancel out. 
Upon these grounds alone, it would be unsafe to con- 
clude that there would be on balance an economy of risk 
under any system of national or world socialism. 

§ 5. The Entrepreneur. There remains, however, an as- 
pect of the problem which is perhaps more important 
than those discussed above. It is probable that risks 
would be estimated and undertaken more wisely or 
less wisely imder a different system of society or of 
industrial organization? Upon this issue, methods of 



114 SUPPLY AND DEMAND 

precise analysis are out of place, but we may have 
something to learn from the emphatic testimony of 
tradition. It has become an axiom of business men 
that, while Governments can manage with more or 
less competence a safe and routine business like a 
Postal Service, their success would be unlikely to prove 
conspicuous in undertakings where the element of 
risk is great. There, it is said, we owe everything in 
the past to the enterprise of individual men (for even 
joint-stock companies have not been notable as pio- 
neers) adventuring their own fortunes in accordance 
with their own unfettered judgment. This contention, 
however much we may desire to qualify it, has un- 
questionably a large measure of truth, and the explana- 
tion is not difficult to discover. For the wise taking 
of risks in industrial development of an experimental 
character, peculiar conditions and special qualities 
are required. First, it is necessary to envisage dis- 
tinctly the promising though risky opportunity, and this 
calls not infrequently for imagination of a none too 
common order. Then it must be studied with insight 
and expert knowledge and weighed by processes which 
are as much intuitive as intellectual. The reasons for or 
against taking a particular business risk are seldom such 
as can adequately be expressed in terms of arithmetic, 
or even by clear arguments the soundness of which is 
proportioned to their logical cogency. The mysterious 
faculty of judgment enters in; and from mental proc- 
esses which defy analysis there emerge ultimately con- 
viction and the will to act. But it is precisely here 
that Government Departments are apt to fail. It is 
here that the individual, who need consult no one but 



RISK-BEARING AND ENTERPRISE 115 

himself, has a pull over any form of organization, 
where decisions are reached by the method of debate 
and agreement among a heterogeneous committee. 
Hence it is that we have come to regard exceptional 
risk-taking as the peculiar province of individual 
enterprise. It is probable that these deficiencies of 
corporate organization are tending to diminish, and it 
is an interesting question how far it may be found 
possible to eliminate them in the future. 

Meanwhile the above considerations have an im- 
portant bearing on the rewards which can often be ob- 
tained from risky enterprises. The number of individ- 
uals who are in a position to envisage a business 
opportunity, and to assess with some confidence the 
chances of success and failure is very limited. Not only 
must they possess special knowledge, ability, imagina- 
tion, confidence in their own judgment, and the ca- 
pacity to act on it; they must also have at their disposal 
considerable financial resources. To combine all these 
advantages represents a union of circumstances which 
is distinctly rare. The fortimate few, who do combine 
them, are thus generally able to extract in the form of 
profits a high price for their services, a price which 
covers not only the strict reward of risk-bearing, and the 
necessary remuneration of their own service, but a 
handsome payment for the special qualities and ad- 
vantages which have been indicated. Profits, moreover, 
may vary between one industry and another, not only 
in accordance with the real risk which is entailed, but 
with the degree to which the supply of special knowl- 
edge, etc., is scarce or abundant. 

This consideration goes a long way to explain the 



116 SUPPLY AND DEMAND 

large fortunes which enterprising business men are 
often able to amass. It also throws some much-needed 
light upon the functions which such men discharge. 
They perform to a large extent the work of manage- 
ment; they supply capital on what may be a consider- 
able scale; but it is the taking of business risk which is 
perhaps their most characteristic function. It is the 
union of these functions which distinguishes them as 
an essentially different type from the salaried manager 
who has invested his savings in rubber or in oil. In 
other languages there is a specific name for the man 
who combines all these three functions; in French he 
is called an "entrepreneur," in German an "Unter- 
nehmer." It is much to be regretted that in Enghsh 
we have no clear corresponding word. The word 
"capitalist" is not uncommonly employed to do duty 
in this connection, but this is a source of much con- 
fusion. For the word is also used, and more appro- 
priately, to include all investors, whether or not they 
are active business men. 

§ 6. Risk-taking and Control. But there is an allied 
confusion of more importance. We commonly suppose 
it to be a leading feature of our present "capitahst 
system" that the control of industry rests in the hands 
of those who supply the capital. Nor, as a general 
statement, is this untrue. But it conceals the essen- 
tial point. Strictly speaking, it is risk-taking with 
which control is associated. The mere lending of 
money carries with it no title to control. Governments 
and municipalities concede no such title to the sub- 
scribers to their loans; nor does a company to its de- 



RISK-BEARING AND ENTERPRISE 117 

benture holders. The shareholders' ultimate control 
is based upon the fact that they bear the financial 
risks of the concern. Nor is this a matter of mere 
legal form. It is not uncommon for ordinary shares to 
carry with them a greater voting power than the pref- 
erence shares of a corresponding value. The principle 
which such arrangements endeavor to express is clear: 
control should rest with him who bears the risk. It 
is with this principle rather than with a muHsh in- 
sistence on the rights of property, that advocates of 
'^ workers' control" and the like have got to reckon. 
It is upon this ground that (as they may quite con- 
ceivably do) they must make good their case. 

§ 7. General Analysis of Profits. Let us conclude this 
chapter by clearing the ground for the next. Earnings 
of management, payments for risk-taking and for the 
special knowledge and advantages associated with it, 
are ingredients of the gross profits of a business. The 
chief element that remains is that of interest on capital. 
Frequently, indeed, it is not the only one. As we saw in 
the last chapter, a farmer may not be required by his 
landlord to pay the full economic rent for his farm; 
and he may therefore make profits above the normal 
level, above the ordinary return for his own services, 
his own capital expenditure, and the risks to which 
he is necessarily exposed. In such a case the farmer is 
really the recipient, as we have already suggested, of 
part of the economic rent of the land; and an element 
of rent accordingly enters into his gross profits. But 
profits may include a surplus element which may arise 
in a great variety of other ways. A business may 



118 SUPPLY AND DEMAND 

possess some decided advantage which is not open to 
competitors; and it may reap high profits accordingly. 
You can, for instance, if you choose, regard the high 
money profits, which, as was suggested in Chapter IV, 
are Hkely to accrue in future to the owners of pre-war 
factories, as a surplus profit of this kind. But while, as 
this illustration indicates, the phenomenon of surplus 
profits becomes of very great importance when we 
seek to study the distribution of wealth, it need not 
detain us here. For the surplus element arises only 
in so far as the costs of a business are lower than the 
marginal costs; and it is the marginal costs, which, 
with gpod reason, we are now endeavoring to analyze. 
The marginal costs must include a normal profit, i.e. a 
profit which will cover earnings of management, the 
reward of risk and enterprise, interest on capital, but 
nothing further. It remains, then, only to consider 
this last element of interest. 



CHAPTER VIII 

CAPITAL 

§ 1. ^ Reference to Marx. Interest is the price paid 
simply for the use of capital. But what is capital, and 
in what does its use consist? What claim has it to be 
regarded as an independent factor of production? Our 
very famiharity with the term, our habit of employing 
it with the rich looseness of every-day Hfe is an ob- 
stacle to the clearness of thought, which is again 
essential. We recognize, most of us, clearly enough 
that capital, although we reckon it in terms of money, 
consists, Hke income, of real things; factories, machinery, 
materials and the hke. It is quite obvious that these 
things are of use, are, indeed, indispensable for pro- 
duction; what more natural than that capital should 
command a price? It almost seems as though we might 
pass, without further ado, to a detailed discussion of 
the forces which determine the amount of this price. 

But this account does not bring out the essential 
point as brief reference to a very famous controversy 
will show. Some ingenious writers in the last century, 
the most notable of whom was Karl Marx, set out to 
prove that, in our modern society, workpeople are 
"exploited," robbed of the "whole produce of their 
labor, " to the full extent of the return which accrues 
to capital. The argument was exceedingly complex 
in detail; but it boils down to this: The factories and 

119 



120 SUPPLY AND DEMAND 

machinery which are admittedly essential to production 
were themselves produced in exactly the same way 
as consumable goods. They were produced by labor, 
working with the assistance of nature, and, again, if 
you choose, of capital in the form of further factories, 
machinery, etc. But these further capital goods can 
in their turn be regarded as the product of labor, 
nature and capital; and so we can proceed until it 
seems as though the element of capital must disappear 
in the last analysis, as though labor and nature were 
the sole ultimate agents of production, and the reward 
of capital represented no more than the exercise of the 
exploiter's power. In one form or another this argu- 
ment still dominates the minds of a large proportion of 
the so-called " rebels'' against the existing social order. 
If we are to meet this argument, if, which is perhaps 
more important, we are to imderstand the true nature 
of capital, we cannot rest content with saying that it 
consists of factories and machinery, and that these are 
essential to the worker. Just as it was well to get 
behind the money terms, in which we often think of 
capital, to the real goods; so we have now to get behind 
the real goods to something else. What this something 
else is, the first chapter may have already done some- 
thing to reveal. 

§ 2. Waiting for Production. Between production 
and consumption there is an interval of time. All 
productive processes take time to accompHsh. The 
farmer must plow the soil and sow the seed months 
before he can reap the harvest which will reward him 
for his efforts. Meanwhile, he must live, and in order 



CAPITAL 121 

that he may live he must consume. If he employs 
laborers he must pay them wages, that they too may 
consume and live. For both purposes he requires 
purchasing power, which represents of course command' 
over real things; and if he has not sufficient purchas- 
ing power of his own, he must borrow from someone 
else who has. In either case it is not enough that the 
farmer and his laborers should work; no less essential 
is it that someone should wait. The farmer must 
wait till he has sold his crops, both for the reward of 
his own labor and for the repayment of the wages he 
advances in the meantime to his laborers. Or, if he 
cannot afford to wait, and borrows in anticipation of 
the harvest, then the lender must wait, until the farmer, 
having sold his crop, is able to repay him. Thus the 
period of time involved in all production gives rise to 
a demand for waiting, which someone or other must 
supply, if the production is to take place. It is this 
waiting which is the essential reality underlying the 
phenomena of capital and interest. It is really this 
which constitutes an independent factor of production, 
distinct from labor and nature, and equally necessary. 

§ 3. Waiting for Consumption. But let us carry the 
argument a step further. After the farmer has sold 
his crops, there are many stages through which they 
must pass, at each of which more waiting is required, 
before they reach the ultimate consumer. But then the 
waiting is at an end. 

This, however, is by no means the case with a great 
number of commodities. Let us take the case of a 
speculative builder. While he is building a house he, 



122 SUPPLY AND DEMAND 

Kke the farmer, must wait (or find someone to wait 
on his behalf, for his own reward, and for the repayment 
of his expenditure on wages and materials. But, after 
the house is built, if he lets it to a tenant for an annual 
rent, his waiting is far from over. Not until many years 
have passed will the rent payments add up to a sum 
which equals or exceeds his outlay. He may, of course, 
sell the house, and thus bring his waiting to an end. 
But then the purchaser must wait, no matter whether 
or not he is the occupier. For no one would consider 
the use of a house for a day, a month, or a year as an 
adequate return for the price it cost to buy. The 
occupier-owner pays for the prospect of its use for a long 
and perhaps indefinite number of years ahead, and he 
must wait to enjoy the benefits for which he pays 
now in full. Waiting is as inherent in the consumption 
of durable things as it is in all production. 

Now most industries are consumers of durable things 
of a very expensive kind. Here we come back to the 
factories and machinery which ordinarily spring to our 
mind at the mention of the word capital. Not merely 
does the construction of these things involve waiting; 
their consumption involves waiting on a vastly larger 
scale. Just as with a house, many years must elapse 
before their derived utility can even approximate to 
their purchase price. It is mainly to supply the waiting 
involved in the consumption of such durable goods, 
that a typical joint-stock company issues shares for 
public subscription. The waiting required to cover the 
period of time, which its own productive process re- 
quires, is largely supplied by means of bank overdrafts 
or other forms of short-period borrowing. More 



CAPITAL 123 

strictly, fixed capital represents the waiting involved in 
the consumption of durable things; circulating capital 
the waiting involved in current production. 

This distinction loses its sharpness when we consider 
not the affairs of a particular business, but the industrial 
system as a whole. Then the period of time involved 
in the consumption of durable instruments falls into 
place as part of the time required for the production 
of the ultimate consumers' goods. We can even, per- 
haps, conceive of an ''average period of production " for 
industry and commerce as a whole; and this conception 
is not without its uses. For it serves to bring out the 
fact that the period of consumption, and the period of 
production in the narrower sense, are only two aspects 
of the same fundamental thing, the interval of time 
which elapses between work and the utility, which is 
its ultimate purpose. It serves, moreover, to make clear 
that anything which lengthens this interval of time 
increases the demand for waiting, or in other words, 
the demand for capital; and, conversely, that anything 
which shortens this interval diminishes the demand 
for capital. 

§ 4. Capital not a Stock of Consumable Goods. But 
the distinction between the two forms of waiting, 
though not fundamental, is none the less worth noting. 
It enables us to keep our theory in conformity with 
fact, to look at the phenomenon of capital the right 
way up; and it is easy, if we are not careful, to slip 
into the habit of looking at it upside down. People 
sometimes speak as though the commodities which 
constitute our capital, instead of being mainly, as our 



124 SUPPLY AND DEMAND 

plain sense tells us that they are, factories, machinery 
and other durable instruments, were rather a store or 
stock of inmiediately consumable goods. The argument 
takes the following form. It is consumers^ goods, 
things like food and clothes, which the farmer, the 
builder and their workpeople consume while they are 
working. To enable them to work, therefore, it is vital 
that such things should not in the past have been con- 
simied as soon as they were made; part of them must 
have been saved, and carried forward for future use. 
Furthermore, the longer the time that the work on 
which people are now engaged takes to yield its product, 
the larger must be this store of consumers' goods. For 
these products, when they are completed, will serve 
(taking society as a whole) to replace the store which in 
the meantime is being used up, so that the longer this 
replacement takes, the larger must be the initial store. 
Conversely, the larger the store of consumers' goods 
available, the more distant is the future for which we 
can afford to work. It is thus the store or stock of 
consumers' goods which represents our real capital; 
for it is the magnitude of this store which determines 
how far we can devote our energies to purposes which 
are remote in time. 

Now this is pure mysticism. Regarded literally, 
it is in direct conflict with the facts. The processes 
of industry are fairly regular and continuous. At any 
moment, large quantities of consumers' goods of almost 
every kind are on the point of completion; at the same 
moment equally large quantities are consumed. The 
things which we buy were finished, very likely, only 
recently; or, if in fact they have lain idle for some 



CAPITAL 125 

time in stock, there is nothing essential or at all helpful 
in that fact. It represents rather a defect — a malad- 
justment which should be rectified. Even many kinds 
of agricultural produce do not need to be carried for- 
ward from one year to another, for they are produced in 
many parts of the world, where the seasons come at 
different periods of the year. It is conceivable, there- 
fore, that we might consume all non-durable things 
the moment they were ready, and the degree to which 
we approximate to this ideal is a mark of the efficiency 
of our economic system. A large store of consumable 
goods is thus not a fundamental necessity of a prosper- 
ous society. 

What is necessary is plainly the power to produce 
these things in large quantities as they are required. 
And this power is furnished by the durable instruments 
of production, which we thus rightly regard as the true 
representatives of modem capital. If it is argued that 
this power to produce consumable goods may be re- 
garded as being in effect a store of consumable goods, it 
must be sternly replied that this is the language of 
symboHsm, not of science, and that symbolism is highly 
dangerous in this connection. The false conception of 
capital as essentially a store of consumers' goods has 
led and still leads to many serious fallacies. It was 
this that gave rise to the notorious doctrine of the 
Wages Fund; the notion that the sum which can at any 
time be paid in wages is equal to the quantity of capital, 
alias consumable goods, which happens to exist. To 
this day it blocks, with an undergrowth of obscurantist 
controversies, the way to a straightforward account 
of the problem of trade cycles. 



126 SUPPLY AND DEMAND 

§ 5. The Essence of Waiting. But it is with positive 
conclusions that we must here concern ourselves. 
What is the essence of this waiting, as we have called 
it? What are its results from the point of view of the 
community? The individual, who saves and lends, 
waits in the obvious sense that he postpones consump- 
tion. He foregoes his right to purchase now a quantity 
of consumers' goods in consideration of the prospect 
of purchasing a larger quantity of such things in the 
future. From the standpoint of the whole community, 
there is a similar postponement of consumption, though 
it need not commence so soon. The store of consum- 
able goods is what it is : the quantity of goods in process 
of manufacture, which will shortly be coming forward, 
is also what it is. For some time, therefore, a sudden 
access of saving cannot affect the quantity of goods 
available for consumption; and if, in fact, they should 
be consumed less rapidly, that will represent an unfor- 
tunate defect, not an essential condition of a smoothly 
working system. The necessary consequence comes 
later. The increased saving will cause labor, materials, 
land, agents of production generally, to be devoted 
to distant purposes. Men will be set to work producing 
durable goods, largely durable instruments of produc- 
tion like ships or railways or factories or plant. If the 
increased saving is considerable, the labor, materials, 
etc., required for these purposes will be withdrawn 
even under our present system, as under a smoothly 
working system they clearly must be, from the pro- 
duction of other and more immediately consumable 
things. Hence, some time later, the supphes of con- 
sumable things will be diminished, while at a later 



CAPITAL 127 

period still they will be more than correspondingly- 
increased as the result of the assistance of the new- 
durable instruments. That is the essence of saving 
from the social standpoint. An early future is sacrificed 
to a more remote future. The aggregate consumable 
income of the present is unaffected; the aggregate con- 
sumable income of the near future is actually dimin- 
ished; it is not until at least some years later that the 
aggregate consumable income is increased. 

§ 6. Individual and Social Saving. This conclusion 
is important: but there is an obvious misinterpre- 
tation against which it will be well to guard. It is 
customary for social moralists to preach thrift and 
saving as a public duty, and to impart to their appeals 
a special note of urgency in times like the present, 
when, as the result of the havoc of the war, destitution 
is widespread over Europe. Now obviously these ad- 
visers do not mean to recommend something which 
will impoverish the world next year and the year after 
and the benefit of which will accrue only in a distant 
future: it is the immediate urgency of the world's 
needs which is rather the substance of their case. Nor 
would it be right to conclude that these wise men are 
the victims of a delusion, and advocate a course, the 
consequence of which they do not understand. The 
explanation of the paradox is simple. The more the 
community as a whole saves now, the less in the near 
future will be the aggregate consumable income of the 
whole community: but not of the remainder of the 
community, exclusive of the savers. It is the saver 
who must wait, whose consumption must be post- 



128 SUPPLY AND DEMAND 

poned to perhaps a distant future; but at no time does 
his saving result in a smaller income of consumable 
goods for other people. The aggregate consumable 
income of the near future will be diminished, but it 
may be better distributed, and it may consist of things 
of a different kind. For consumers' goods, we must 
remember, comprise champagne and motor cars as 
well as food and clothes; and, if a rich man saves, it 
may be purely articles of luxury, the production of 
which will shortly be diminished. Moreover, if his 
saving has the effect of transferring purchasing power 
to impoverished people, like those in Central Europe, 
it will not be devoted to a distant future; it will very 
likely be devoted to quite immediate ends. In other 
words, it may not result in any ''creation of capital"; 
it may not represent any saving on the part of the 
community as a whole. A relatively rich man waits, 
and a relatively poor man anticipates his income to a 
corresponding extent; and it is precisely this that is so 
urgently desirable in a time of widespread poverty and 
chaos. 

This is no matter of hair-splitting, and making 
plain things obscure. While it is always better for the 
rest of us that an individual, who can afford to save, 
should save rather than spend (though it might be 
better for us still if we could have his money to spend 
ourselves) and while this is the more important the 
greater is the poverty which generally prevails; yet, 
as a community we cannot save so much, we ought 
not to save so much, when we are impoverished as 
when we are prosperous. It is vital to appreciate this 
truth, because, as we shall see, by no means all the 



CAPITAL 129 

saving of the world is done by individuals. There are 
many forms of ** collective saving/' which take place 
in actual fact; still more which we are often urged to 
undertake. And it is of practical importance to realize 
that the very considerations, which call most urgently 
for individual thrift, forbid a great indulgence in such 
projects. A time of national poverty is not a time 
when it is suitable for the State to embark on large 
schemes of capital development: we require our re- 
sources for more immediate ends. Faced with such 
problems, our practical sense may no doubt sufl&ce to 
keep us straight; but it is apt to do so at the expense 
of a complete inversion of the real issues. If, for in- 
stance, we call for Governmental retrenchment on 
what we deem extravagant policies of housing and 
education, we usually speak as though they represented 
the profligacy of a spendthrift as contrasted with 
the saving that is indispensable. The truth is rather 
that these policies represent a saving, an investment for 
future purposes, which may conceivably be greater 
(this must not be taken as representing my personal 
opinion) than the community can properly afford. 
This is another instance of what I mean by looking 
at the problem of capital the right way up. 

§ 7. The Necessity of Interest. It is only now that 
we are in a position to appreciate the true functions 
of a rate of interest, and the nature of its claims to be 
regarded as a "real cost." Interest, it is sometimes 
said, is necessary to provide for the future. It is far 
more certain that interest is necessary to provide for 
the present. It is a matter of legitimate doubt how far 



130 SUPPLY AND DEMAND 

it is necessary to pay interest to secure a supply of 
capital; there is no doubt at all that it is necessary to 
charge interest to limit the demand for it. As we saw in 
Chapter I, a world socialist commonwealth would 
require to retain a rate of interest, if only as a matter 
of bookkeeping, in order to choose between the various 
capital undertakings that were technically possible. 
And this is the primary function which the fate of 
interest fulfils in our present-day society. It separates 
the sheep from the goats. It serves as a screen, by 
means of which capital projects are sifted, and through 
which only those are allowed to pass which will benefit 
the future in a high degree. For this essential purpose 
it is hard to imagine how a better instrument could be 
devised. 

§ 8. The Supply of Capital. Let us dwell for a moment 
on this image of a screen, or sieve. One condition of a 
good sieve is that its meshes should all be of the same 
size. This condition the rate of interest almost perfectly 
fulfils. But it is also important that the meshes should 
be of the right size. Whether this is true of the actual 
rate of interest is a far more doubtful matter. It is, 
iudeed, plain that it is not altogether devoid of merit in 
this respect. In times of general world poverty, like 
those which follow upon a great war, it is desirable, as 
has been argued, that more of our productive resources 
should be devoted to immediately useful purposes, and 
a smaller portion dedicated to a distant future. This 
readjustment the rate of interest helps to bring about. 
For it rises to a higher level, and there is accordingly 
a strong inducement to all manufacturers and traders 



CAPITAL 131 

to economize their use of capital, and thus to set free 
productive resources for more urgent needs. But, 
while the meshes of the sieve, as it were, contract in 
times when it is desirable that they should contract, 
we have no reason for supposing that they will contract 
in just the degree that is desired, neither more nor less; 
or, indeed, that at any time they approximate to the 
right size. We in the twentieth century owe much 
of the material wealth that we enjoy to the fact that 
over the last century men saved as largely as they 
did. But our natural gratitude should not restrain 
us from doubting whether they were really well advised 
to do so. If we ask the question how they managed to 
do so, our doubts are deepened. For first place among 
the explanations must be assigned to the inequality 
in the then distribution of wealth. It was because 
many men in England were rich enough to save that our 
railways were built, and the resources of new Continents 
were opened up. But England, a century or even half a 
century ago, was not really a rich community. And if 
the national income in those days had been distributed 
more evenly among the people, can we doubt that they 
would have spent a far larger proportion of it on 
immediate needs; can we doubt that they would have 
been right to do so? We may rather doubt, in view 
of the reactions of poverty on physical and mental 
efficiency, on social harmony, even possibly on popula- 
tion, whether we to-day would have been really injured 
as much as might appear. How, then, can we suppose 
that the sum of the amounts which it suits individuals 
to save will bear any close relation to the resources 
which the community can properly devote to future 



132 SUPPLY AND DEMAND 

ends? Are we to regard an unjust distribution of wealth 
as a mysterious dispensation of Providence for securing 
perfect harmony between the future and the present? 
The point need not be labored further. There are no 
grounds for assuming that we save, as a community, 
even roughly what we ought to save. If we wish to 
believe we do, we must turn for support from economics 
to theology. 

It is important to be clear upon this issue in order to 
distinguish it from another, with which it sometimes 
seems to be confused. This is the question, briefly 
outlined in Chapter II, of the effect of changes in the 
rate of interest on the supply of capital. As was there 
indicated, there are good reasons for supposing that a 
fall in the rate of interest would induce some people 
to save more, and conversely. But the balance of prob- 
ability is in favor of the conclusion that the net effect 
of changes in the rate of interest, though perhaps slight, 
is usually of the more ordinary kind. The decisive argu- 
ment in this connection is the fact, upon which we have 
just touched, that savings are supplied largely by people 
who are relatively rich, and who become richer when the 
rate of interest rises. For at this point it is necessary to 
be careful. It is easy to slide from the above conclu- 
sion into an argument of the following kind. A higher 
rate of interest leads to more saving; it is thus necessary 
to evoke more saving; it is thus required as an incentive 
to induce people to incur the sacrifice of waiting; this 
sacrifice represents the ''real cost" for which interest 
is paid. 

This terminology of incentive, inducement and 
sacrifice is of very dubious validity. A rich man, who 



CAPITAL 133 

is made richer by a rise in the rate of interest, will 
probably save more, but it will be rather because he 
has become richer than because he is tempted by 
the higher rate: and the less we talk about his sacrifice 
the better. Nor is it clear that the attraction of a high 
rate of interest is an operative factor on the mind of a 
man to whom saving means a real sacrifice of immediate 
comfort or enjoyment. Certainly it is only one among 
many factors, and seldom an important one. A really 
poor man will think not so much of the annual income 
which will accrue from his savings, as of the capital 
sum upon which he or his family can fall back if a 
rainy day should come. And for this purpose he might 
save as much as he saves now, even if there were no 
interest to be obtained thereby. He might even be 
prepared to lend what he had saved, at least to banks 
(a deposit with a bank is in effect a loan), for the mere 
advantage of safe custody. The people who save rather 
for the sake of the capital sum that can be realized than 
for that of the annual interest are very numerous, and 
probably include many men in receipt of quite consider- 
able earned incomes. Moreover, those who consider 
mainly the future annual income which their savings 
will yield them, are usually more concerned v/ith its 
absolute amount than with the ratio it bears to the 
amount they must save in order to acquire it. For this 
reason, as has been often recognized, they may save 
less when the rate of interest rises, since a smaller 
quantity of savings will insure to them the future an- 
nual income they desire to obtain. There is no need to 
be dogmatic upon any of these points. The psychology 
of saving is both complex and obscure. Our conclusion 



134 SUPPLY AND DEMAND 

must be the negative one that we have insufficient 
evidence to warrant the assertion that the particular 
rate of interest which happens to prevail is a measure of 
the sacrifice involved in saving, even in the case of what 
we might regard as the ''marginal saving." And, if 
we cannot assert this, we must be careful not to assume 
it as the basis of other arguments, or as part of a general 
analysis of price or exchange value. 

It is of some interest to observe that the difficulties 
which our world socialist commonwealth would en- 
counter if it attempted to dispense with the rate of 
interest, would not necessarily include that of obtaining 
a supply of capital. It might, indeed, not find it easy 
to determine the proportions in which it should allocate 
its productive resources between immediate and distant 
ends. Our present system cannot be said to have evolved 
satisfactory principles for the solution of this question; 
and the socialist commonwealth would have to work 
out its own solution. But when it directed that labor 
and materials should be devoted to purposes of long- 
period utility, there would be an automatic collective 
saving, of which no one would be conscious as an 
individual sacrifice. Even at the present time, our 
capital is not supplied entirely by the savings of indi- 
viduals, but to an extent, which though quite incalcu- 
lable is yet certainly considerable, by involuntary saving 
of an essentially similar type to the above. 

§ 9. Involuntary Saving. When a municipality embarks 
on a municipal tramways scheme or any other industrial 
enterprise, and pays off by means of a sinking-fund 
the capital which it borrows in the first instance, the 



CAPITAL 135 

proceeding amounts, as the defenders of municipal 
trading have rightly claimed, to a compulsory and 
unconscious saving on the part of the citizens. Their 
consumption has been postponed willy-nilly as the 
result of the increased rates or the high charges which 
they have had to pay; and, when the subscribers to 
the original loan have been paid off, the capital of the 
community is enhanced to the extent of that loan. 
Central governments might similarly increase the supply 
of capital by devoting annual revenue to capital pur- 
poses; though their actual record, as it happens, is 
mainly of a different kind. But what is chielfly a possi- 
bility in the case of Governments has actually been 
carried out on an enormous scale by other institutions. 
The development of the joint-stock company system has 
introduced a new factor into the problem of the supply 
of capital, which is of immense though but dimly 
perceived importance. The directors of a company 
are technically no more than the servants of the share- 
holders. It is the profit of the shareholders that it 
is the directors' duty to promote with a single mind, 
and the whole capital of the concern, including its 
reserves both open and concealed, is the shareholders' 
exclusive property. But realities have a way of differ- 
ing from forms, and just as in political affairs it is com- 
mon to regard the State as a very different thing to the 
people who compose it, as a subhme entity with a sepa- 
rate existence of its own, so directors are apt to distin- 
guish between the company and the shareholders. It is 
the company to which they owe allegiance. To pay 
away in dividends to shareholders money which they 
could employ in extending the business or strengthen- 



136 SUPPLY AND DEMAND 

ing the position of the company appears to some direct- 
ors a necessity hardly less unpleasant than an increased 
wages bill, or an Excess Profits Duty. Concessions must 
indeed be made to the shareholders' rapacity: but 
when something has been done in this direction, dust 
can easily be thrown in their not very observant eyes. 
Reserves, which within limits are a necessity of sound 
finance, can be accumulated beyond those limits, and, 
when the further limits of an extreme but just argu- 
able conservatism have been passed, there remain the 
innumerable devices, known to every resourceful 
Board, of hidden reserves, the secret of which is un- 
menaced by the meager information of a balance-sheet. 
In all this the shareholder, as the directors occasionally 
assure themselves, has no real grievance, for he will 
gain in the long run, from the appreciation in the capital 
value of his shares, all and perhaps more than all that 
he foregoes in the meantime in the way of dividends. 

In the long run the shareholder is not injured; but 
in the meantime he is in effect compelled, without 
any consciousness of the proceeding, to save and to 
reinvest in the company a portion of the dividends, 
which he might otherwise have spent. The reserves 
which are accumulated are not allowed to lie idle: 
they are employed either in what are really capital 
extensions of the business, or in the purchase of outside 
securities, and in either case they represent an increase 
in the total supply of capital. The principal which 
these proceedings represent is capable of indefinite 
extension. 

But however possible it might be to secure a supply 
of capital without the inducement of a rate of interest. 



CAPITAL 137 

that rate is indispensable for dealing with the demand. 
It is no good sajdng, ''Three per cent seems a fair rate 
of interest; let us try and limit it to that." Given 
the amount of savings which are supplied, the rate of 
interest must be allowed to reach whatever figure 
is necessary to confine the demand to that amount. 
Given the quantity of resources which you have avail- 
able for future needs, the meshes of the sieve must be 
made as narrow as is necessary to confine the projects 
that pass through within those limits. And so, indeed, 
it becomes necessaiy for any particular business to pay 
for its capital interest at the market rate, not so much 
to secure the saving of it as to secure its allocation from 
the common pool. 

§ 10. Interest and Distribution. It is unavoidable that 
this interest should accrue to whoever it is that sup- 
plies the capital. If the capital were supplied, as it 
might conceivably be, collectively by the conGimunity, 
the interest would accrue to the community, and all 
would be well. But as things are, the capital is supplied 
mainly by the savings of individuals, and largely by 
individuals confined to a relatively narrow class. The 
profits of Capital have thus a vital influence on the 
very serious matter of the distribution of wealth be- 
tween social classes. Now, as experience shows, there 
is no element in profits which is capable of such radical 
change in so short a space of time, as is the rate of 
interest. Even before the war it had become hard for 
people in Great Britain to realize that 3 per cent Consols 
had stood at 114 as late as 1896. "How blest," wrote 
two cynical satirists of society in the same period: 



138 SUPPLY AND DEMAND 

"'How blest the prudent man, the maiden pure, 
Whose income is both ample and secure. 
Arising from Consolidated Three 
Per cent Annuities, paid quarterly." ^ 

It is impossible to read those lines now without a 
sense of irony, different from that which they were 
intended to convey. 

Not only is the rate of interest now double what it 
was a generation ago; we have no good reason to suppose 
that the present high level will quickly be reduced. 
The havoc of the war, of which the widespread poverty 
of Europe and the huge debts of Governments are but 
two different aspects, makes it almost inevitable that 
the rate should rule high in the present decade. This 
cannot but exercise a profound influence, of a most 
disquieting character on the general level of profits, 
and to a lesser extent (for here we must allow for the 
effects of high taxation) on the distribution of real wealth 
between social classes. Here we are on the threshold 
of tremendous issues. We almost feel the earth quake 
beneath our feet. We hear the muffled roar of far- 
reaching social controversy: 

"And 'mid this tumult Kubla heard from far 
Ancestral voices prophesying war." 

1 Narcissus, by Samuel Butler and Henry Festing Jones. 



CHAPTER IX 

LABOR 

§ 1. ^ Retrospect on Laissez-faire. When, a century 
and a half ago, the foundations were being laid in the 
Western world of systematic economic theory, the 
public attention was much occupied with a subject, 
which indeed has not ceased to hold it: that of the 
failings of Governments. The general interest in that 
topic was shared by the pioneers of economic thought, 
of whom, in Great Britain, Adam Smith was the most 
notable. It was indeed their practical concern with the 
concrete economic issues of the day which very natu- 
rally gave the impetus to their scientific quest. It was 
hardly less natural that they should have expressed 
their opinions on these concrete issues with considerable 
emphasis. 

Now the keynote of their practical conclusions was 
that Governments were doing immense mischief by 
meddling with a great many matters, which they would 
have done better to leave alone. In this they were in 
general agreement with one another; incidentally — 
let there be no mistake about it — they were right. But, 
as invariably happens in public controversy, their 
opinions became crystallized in a compact formula, or 
cry, with unduly sweeping impHcations. This was the 
cry of "laissez-faire J' Let Governments preserve law 
and order; and leave the economic sphere alone. The 

139 



140 SUPPLY AND DEMAND 

economists picked no quarrel with this formula; it 
served well enough for workaday purposes to indicate 
the lines of policy which they rightly thought essential 
in their day. 

The history of this cry is the history of every cry 
which has won a wide acceptance from mankind. It did 
good work for perhaps half a century; but then many 
crimes were committed in its name. The instrument 
which had been forged to clear away a noxious tariff 
jungle and the monstrous laws of Settlement, was 
turned against Lord Shaftesbury and the Factory Acts. 
Not only was inaction recommended to Governments 
as the highest wisdom; other institutions, like trade 
unions, were warned off the economic grass. An ideal 
of perfect competition became an idol to which much 
human flesh and blood were sacrified. 

But, what is more to our present purpose, the idea 
took root of an intimate association between the laws 
of economics and the policy of laissez-faire. People 
who opposed some long-overdue measure of State 
regulation believed themselves to be justified by the 
eternal verities of economic law, and this claim even 
the advocates of the measure seldom ventured to 
dispute. They took refuge rather in a conception of 
economic law as a dangerous monster, whose claws 
must be clipped in the interests of the higher good. 
This notion that all interference with so-called "free 
competition," is a violation (though very likely fully 
justified) of economic laws has sunk deep into our 
common thought. So that to this day, whenever we 
see at work the hand of a State department, a trust or 
a trade union, we are apt to say ''Demand and supply 



LABOR 141 

are here in abeyance,'^ and possibly we add "A good 
thing too." Since in the matter of wages, the hand of 
the trade union is very generally evident, it is impossible 
to discuss the subject-matter of this chapter, until we 
have rid our minds of this quite baseless prepossession. 
To sweep away this cobweb, I urge the reader to 
recall here the general tenor of the analysis of the 
preceding chapters. Whether we were dealing with the 
price of an ordinary commodity, with joint products, 
land or capital, we came across relationships which 
seemed altogether more fundamental than our present 
industrial system; nor, we may incidentally observe, 
were we ever required to suppose that the present 
system was one of ''perfect competition." These 
relationships were almost invariably such that even a 
world socialist commonwealth would find it necessary 
to maintain them. It was not suggested, and most 
certainly it must not be thought, that a world socialist 
commonwealth, or even a more modest remodeling of 
the social order would not effect great changes, possibly 
for good, and possibly for ill. The same economic laws 
might be made to bear very different fruits, but they 
themselves would remain unchanged. What is true in 
all these other fields — this should be our predisposi- 
tion — is not likely to be quite untrue in the field of 
labor. 

§ 2. Ideas and Institutions. Another point is worth 
noting here. We are sometimes advised to distinguish 
sharply between "What should be" and "What is"; 
often two very different things. The advice is perti- 
nent and useful, particularly in the sphere of sociology. 



142 SUPPLY AND DEMAND 

But our incorrigible habit of confusing the two things 
together is not without justification, or at least excuse. 
For, in fact, they gravitate towards one another with a 
force which is just as strong as the capacity of man for 
understanding and controlling his environment. When 
we have a system which is clearly bad, and when we see 
our way to make it better, we generally make the change 
however tardily. Our sense of ''What should be" thus 
reacts upon "What is.'* Meanwhile, until we can make 
the system better, our appreciation of ''What is" 
affects our sense of "What should be." And the more 
so, as we are sensible. For "What should be" is 
pre-eminently an affair of relativity. A man may 
hold very strongly that equal pay to every individual 
is desirable, as he puts it, as an ideal. But this will not 
prevent him, in a world in which managers are paid far 
more than manual workers, from maintaining hotly 
(at any rate, if he is sensible) that to pay the manager of 
a particular concern a manual worker's wage would 
be monstrously unfair. He would also argue that it 
would be highly inexpedient. Equity and expediency 
are, in fact, intricately intertwined in our sense of 
"What should be"; and our sense of "What should 
be" in the particular is governed by our knowledge of 
"What is" in the general. 

These may seem unnecessary commonplaces. But 
they have a vital bearing on the modus operandi of eco- 
nomic laws. These laws do not work in vacuo. They 
work through the medium of the acts of men. The acts 
of men are greatly influenced by their institutions, and 
by their ideas of right and wrong. Both institutions and 
ideas may serve to smooth rather than obstruct the 



LABOR 143 

path of economic laws; because the laws may represent 
either "what should be" in the general, or ''what is'' in 
the general, and therefore "what should be" in the 
particular. This may hold true even of a trade union 
or a sense of "fair wages." The business of economic 
theory is not to justify a regime of laissez-faire, still less 
to show the folly of bringing morals into business. Its 
value is rather that it may help us, by improving our 
understanding, to shape our institutions, and to adopt 
our moral sentiments so as to promote the public wel- 
fare. With these general notions in our minds, let us 
turn to see how stands the case with Labor. 

§ 3. The General Wage Level. The term Labor may be 
used in a broad or in a narrow sense. It may be confined 
to weekly wage-earners: it may be extended to include 
all those who work, as the phrase goes, "with either 
hand or brain." It is with all classes of Labor, in the 
broadest sense of the term, that we must here concern 
ourselves. It will be convenient, however, in the first 
instance to ignore the differences between them, and to 
consider the forces which determine what we may 
regard as the general wage-level. 

The general laws of supply and demand hold good. 
The wages of labor tend to a level at which the demand 
is equal to the supply. For, if the demand exceeds the 
supply, if, in other words, labor is scarce, wages tend to 
rise, sooner or later in any case, and the more promptly 
in proportion as the workpeople are organized. Con- 
versely, if the supply exceeds the demand, if in other 
words there is general unemployment, wages tend to fall, 
and the strongest trade unions cannot resist the ten- 



144 SUPPLY AND DEMAND 

dency, though they may delay it. Moreover, the higher 
the wages that must be paid, the smaller, other things 
being equal, is the demand for labor. For, even if 
we leave foreign competition out of account, and con- 
sider, as it were, labor throughout the world as a whole, 
the demand for labor is by no means inelastic. It is 
derived along with the demand for the other agents of 
production in the manner described in Chapter V. 
As was there shown, the greater the supply of the other 
agents of production, the greater is likely to be the 
demand for labor; but these other agents can be sub- 
stituted for labor in a great variety of ways, and an 
increase in wages (unless accompanied by increased 
efficiency) will make it profitable for employers to effect 
such a substitution, where it was not profitable before. 
Thus, higher wages for the same labor efficiency must 
stimulate the tendency for capital to act as a substitute 
for labor at the expense necessarily (since the aggregate 
supply of capital will not be increased thereby) of its 
tendency to serve as a complement; and this must mean 
a decrease in the volume of employment. Hence the 
power of labor to secure a general advance of wages 
by concerted or simultaneous trade union action, ap- 
plied if you will, not merely to every industry, but to 
every country, is necessarily very limited. Beyond 
a certain point, such a policy must result in general 
unemployment; and, if pushed sufficiently far, in un- 
employment so extensive that it would continue even 
in periods of active trade. Such a policy could neither 
be maintained in practice nor would it be a wise policy 
from the workers' point of view. 

In other words, given on the one hand the conditions 



LABOR 145 

of the demand for labor (i. e. the supply of capital, 
natural resources, business ability, risk-bearing and 
kuowledge of technical processes, etc., which happens 
to exist), and given on the other hand the supply of 
labor (i. e. both the numbers of workpeople and their 
efficiency), the wage-level in the long run is fairly rigidly 
determined. The introduction of the phrase "in the 
long run" in this connection is apt to provoke com- 
ment which may be pertinent, but may be miscon- 
ceived. The worker, it is pointed out, is deeply con- 
cerned with "the short run" in which he has to live. It 
is very true; and it is this that supplies one of the many 
justifications of trade unionism. To secure for the 
workers advances of wages, which economic conditions 
justify, sooner than would otherwise have been obtained, 
is certainly no trivial or contemptible function. But 
it is none the less an illusion to suppose that the general 
wage-level can be appreciably and permanently raised 
by trade union action, except in so far as it increases 
the efficiency of the workers or incidentally stimulates 
the efficiency of the employers. 

§4. The Supply of Labor in General. The efficiency 
of labor may be regarded as affecting either the demand 
for labor on the one hand or the supply of it on the 
other, according as we look at the matter from the 
worker's or the employer's standpoint. The employer 
is concerned with the labor costs per unit of his output, 
the worker is concerned with the wages he receives. 
An increase in the efficiency of labor may, and usually 
will, mean both a decrease in labor costs to the employer 
and an increase in the earnings of the worker. It is 



146 SUPPLY AND DEMAND 

thus wholly to the good. But the effects of an increase 
in the supply of labor in the sense of a growth in the 
numbers of the population are far more dubious. Un- 
accompanied by an increase in the demand for labor, 
it must result in a diminished remuneration for the in- 
dividual worker. To some extent indeed the demand 
for labor would almost certainly be increased. The 
supply of Capital may expand, perhaps proportion- 
ately, perhaps more than proportionately to the in- 
crease in population. But one factor of production, as 
we have seen, is not capable of such expansion. This 
is the factor of Land, or Natural Resources. It is the 
limitation of this factor which gives rise to what we 
have most of us heard of as The Law of Diminishing 
Returns. It is this that is the essence of the problem 
of Population, portrayed in somber hues more than a 
hundred years ago by Malthus. 

This problem will form the subject of the sixth vol- 
ume of the present series. In the meantime it may be 
suggested that we are easily credulous if we suppose 
that the problem has been finally disposed of by the 
peculiar progress of an abnormal century. But that 
experience has at least destroyed the view that there 
need he, or even is in fact in Western countries, a rela- 
tion between real wages and the numbers of the people so 
close and direct that an improved standard of living 
must be temporary only, doomed to destroy itself by the 
increased population it engenders. One may perhaps 
go further and say that it is doubtful even in what di- 
rection changes in remuneration will influence the 
aggregate supply of labor. When we pass to "what 
should be," it is plain that there is nothing whatever 



LABOR 147 

to be said for the sort of relation indicated above. The 
view once widely held that the principle of population 
must inevitably keep the mass of people close to the 
verge of the bare means of subsistence was no statement 
of a desirable ideal. It was a nightmare; a nightmare 
none the less though it may haunt us yet. It is far from 
fanciful to suggest that it is because this relation is so 
obviously not ''what should be*' that it may be ceasing 
to hold true in fact. But it would be very fanciful 
indeed to maintain that as yet "what should be" is 
represented by the actual population. Thus, just as 
with capital, so with labor, there is no reason to sup- 
pose that the aggregate supply is determined by any 
fundamental economic law, or corresponds in practice 
to what is socially desirable. 

§ 5. The Apportionment of Labor among Places. Again, 
as with capital, it is when we turn to the apportionment 
of labor between different employments that both 
economic law and social ideal make their appearance. 
It will be well, however, to consider briefly in the first 
instance the different question of its apportionment 
between places. This was hardly necessary in the case 
of capital, because the possibilities of foreign invest- 
ment are very numerous and easy: the mobility of 
capital is thus sufficiently strong (once again it is only 
marginal adjustment that is necessary) to establish 
over at least a large part of the world something near to 
a uniform rate of interest. But this is not the case with 
labor. People do indeed move from place to place 
within a country, and from one country to another, in 
response to economic opportunities. That even the 



148 SUPPLY AND DEMAND 

latter movement may be a considerable thing, the 
present population of the United States is a striking 
testimony. But obviously the mobility is very in- 
complete. Here, then, we have what we might loosely 
call an economic law that labor tends to "flow" (as 
it is sometimes unhappily phrased) to those places 
where it can command the highest reward; we have this 
tendency in evidence, but it is far too weak to enable us 
to lay down what vv^ould deserve more strictly the title 
of an economic law, that in the long run the reward of 
the same kind of labor is roughly equal in all places. 
Perhaps we can say this for m.any districts in a single 
country; but for few countries is this true as between 
all their districts. As between countries, it is not re- 
motely true. 

Here, however, the imperfection of economic law is 
balanced by an extreme uncertainty as to the ideal. 
Perfect mobility of labor may be economically desirable 
in a very narrow sense of the term; but it opens out a 
vista of racial, national and cultural problems, into 
which it will be better for us not to enter here. We 
must take for granted the population of a country, 
hke that of the world, as a given fact. 

When we do this, the question of its remuneration 
is on all fours with the more general question discussed 
above. That the remuneration of the labor of a coun- 
try is mainly governed by the relations between demand 
and supply is an inexorable fact. In view of the interna- 
tional mobility of capital, the main distinctive factor in 
the demand for the labor of a particular country is the 
supply of natural resources, which it knows how to use. 
Where the natural resources are great relatively to the 



LABOR 149 

population, there wages will rule high; where the con- 
verse is true, wages will rule low. This result of eco- 
nomic analysis is abundantly confirmed by experience. 
The relatively high wages in the new world, the low 
standard of living in the densely populated East; the 
economic history of Ireland are so many object-lessons 
of its truth. 

§ 6. The Apportionment of Labor among Social Grades. 
The question of the apportionment of the labor of a 
country among different employments falls under two 
heads. Some differences of occupation are associated 
particularly in Great Britain with differences of what 
we know as class. The movement of labor between 
different social grades is clearly a very different thing 
from its movement between different occupations in the 
same grade. The grades themselves are not easy to 
define: not a little ingenuity has been expended on the 
attempt, and perhaps the best brief classification that 
has been put forward is one which divides labor into the 
following four grades: — 

(1) Automatic manual labor. 

(2) Responsible manual labor. 

(3) Automatic brain workers. 

(4) Responsible brain workers. 

But the matter is one perhaps for the satirist of manners 
rather than the economist. It suffices for our purpose 
that the distinctions, however vague, are very real. 

It is obvious the mobility of labor between the oc- 
cupations of a platelayer and a barrister is not very 
great. It may seem perhaps to be even smaller than it 



150 SUPPLY AND DEMAND 

is. For here it is important to bear in mind a general 
consideration which is equally applicable to horizontal 
movements within any social grade. There may be a 
considerable movement of labor between different em- 
ployments without any individual worker having to 
change his occupation. The personnel of any industry 
is constantly changing. At one end, men die, retire, or 
are pensioned off; at the other end, young recruits are 
taken on. By a diversion of the new recruits from one 
employment to another, a radical change can be made 
in the occupational census in a comparatively short 
space of time. It is in this manner that such move- 
ment as takes place is largely effected at the present 
time. Within the ranks of the professional classes, a 
man does not commonly leave the profession to which 
he has been trained. But his choice of profession is de- 
termined by him or his parents not solely on pecuniary 
grounds but usually with an anxious scanning of the 
general prospects, which include pecuniary advantages 
together with many other things. The same thing is 
true in no small measure of manual wage-earners. This 
general consideration must be borne in mind through- 
out the remainder of this chapter. 

But even the sons of platelayers do not commonly 
practise at the bar. The obstacles in the way are vari- 
ous and subtle. Many of them are ideas, inherited 
from a bygone epoch, about keeping other people "in 
their proper stations," which the whole drift of circum- 
stance, and the spirit of the age are rapidly wearing 
down. In the new world such obstacles are rare. But 
an obstacle of a more tangible and formidable kmd 
arises from the fact that the liberal professions and 



LABOR 151 

many business careers require a long and expensive 
education and training, which the platelayer is quite 
unable to afford to give his son. 

Now this expense of training is highly relevant not 
only to ''what is/' but to ''what should be." It in- 
cludes, it should be observed, a negative as well as a 
positive element; a long period of waiting before income 
begins, as well as the actual outlay on educational and 
other charges. When the burden both of the waiting 
and the positive costs must be borne either by the in- 
dividual or the family, there are few people who would 
seriously dispute that this goes to justify, on grounds 
of fairness as well as of expediency, a higher level of an- 
nual remuneration later on; though many people would 
doubtless argue that the amenities and dignities of the 
professions should be taken into account on the other 
side. But the same consideration makes it a matter of 
legitimate doubt whether it would be desirable, even as 
an ideal, that the community should provide so com- 
pletely the costs of training and of maintenance in the 
waiting period, as to make it no longer "fair" that the 
individual should be remunerated more highly than 
workers in less expensive occupations. For this would 
mean that more labor would be absorbed in the former 
employments than in principle would be socially desir- 
able, for reasons which the argument of the next chap- 
ter will make plain. But the most desirable number of 
doctors, barristers, teachers, etc., is not a thing which 
can be settled on purely economic grounds, and it is 
unprofitable to carry further this particular line of 
thought. Few people would advocate, as an ultimate 
ideal, that the remuneration of the professional grades 



152 SUPPLY AND DEMAND 

of labor should exceed that of lower grades by more than 
the extra expense of training and waiting they involve. 
That the excess is usually greater than this at the 
present time seems very probable: though it is a matter 
on which it is very hard to generalize. But it would 
certainly be far greater than it is if the principle of 
laissez-faire ruled supreme in these affairs. Fortu- 
nately it does not, and has never done so. Even before 
the days of free elementary education, the endowment 
of education was not unknown. The ancient public 
schools and universities, which have come down to us 
from the Middle Ages, are a standing witness to what 
in this field a far poorer community thought fit to do. 
Their systems of scholarships and exhibitions, no less 
than their courts and towers, deserve our notice. For 
these were designed to form what we now call "a lad- 
der" by which talent could climb from the humblest 
origins to the callings which then seemed the summit 
either of spiritual or of worldly ambition. 

This reference to "talent" makes it well to consider 
here a factor which necessarily complicates, though it 
does not substantially affect, the whole argument of 
the present chapter. There are differences of natural 
ability, which no education or training can obliterate, 
which it should rather be their business to excite. 
These differences are associated to a great extent with 
differences of occupation; they should he so associated 
far more closely than in fact they are. They are also 
associated with differences of remuneration even within 
the same occupation; "what should be" here is a ques- 
tion which we may excuse ourselves from discussing. 
The principle which, however vague, is sufficient for 



LABOR 153 

our present purpose is that the same natural ability 
should command the same reward in all occupations, 
subject to differences which should not exceed the dif- 
ferences of educational cost and initial waiting they 
involve. We cannot assert, as an economic law, that 
this is generally true in fact. If ever it becomes true, 
it will be due not to ''laissez-faire,'^ or "free competi- 
tion," but to social arrangements, which express a 
sense of what is right. 

§ 7. The Apportionment of Labor among Occupations. 
When we pass to the apportionment of labor among 
different occupations in the same social grade, the same 
principle as to "what should be" apphes in a simpler 
form. Equal natural ability should command an equal 
reward in all occupations; assuming that differences 
in cost of training can be ignored. The reward must, 
of course, be interpreted not in terms of money only 
but of "real wages," with allowance for the varying 
amenities of different tasks. Now it was here that the 
extreme advocates of laissez-faire made one of their 
cardinal mistakes. They assumed that this ideal would 
be best secured by "perfect competition." The em- 
ployer would choose the worker who would come for 
the lowest wage; the worker would choose the employer 
who would pay him the highest wage; and so, by a proc- 
ess similar to the higgling of a commodity market, the 
desirable uniform wage-level would become established. 
But in fact the conditions of the labor market differ 
greatly from those of a commodity market. People 
are ignorant, do not look ahead, cannot afford to risk 
the loss of a job, however wretched, which they happen 



154 SUPPLY AND DEMAND 

to have got. For reasons such as these, a considerable 
departure from laissez-faire is necessary in order to 
realize the theoretical results of laissez-faire. To pre- 
vent the putting of boys in large numbers into "blind 
alley'' occupations, you must supplement the foresight 
of parents with Juvenile Employment Exchanges and 
After-Care Committees. To secure a proper uniformity 
of wages within the same occupation, you must have 
trade unions. To secure a proper uniformity between 
different occupations, you must have again trade unions, 
or, failing them, Trade Boards. 

That the actions of trade unions are very largely of 
this type is a fact insufficiently appreciated by the 
middle-class public. The elaborate system of piece-rate 
lists which has been evolved in the Lancashire cotton 
industry is primarily designed to secure the same wage 
for workers of equal efficiency in all mills, irrespective 
of the degree to which the machinery is antiquated or 
up to date. This result is wholly to the good: not only 
does it secure ''fairness" for the worker, it stimulates 
the employer wonderfully to efficiency. The same re- 
sult could never be secured so effectively by the free 
play of competition. But this tendency, which is easily 
-the predominant element in the trade union regula- 
tions of the cotton trade, is at least an important ele- 
ment in the policy of "The Common Rule" of all trade 
unions, though it may often be mixed up with the more 
questionable tendency to eliminate differences of pay 
for differences of natural ability, and the unquestionably 
bad tendency to discourage output. As between dif- 
ferent occupations, the insistence of a trade union that 
wages must be leveled up towards the wages obtaining 



LABOR 155 

in similar trades acts again as a far more powerful force 
than competition. 

But the actions of trade unions are by no means 
wholly of this type. They often serve rather to secure 
still higher wages for workers who, comparatively 
speaking, are already highly paid. It makes little 
difference whether this effect is secured directly by 
wage demands, or indirectly by restricting the right 
of the entry to the trade. In either case the conse- 
quences are the same, and there should be no ambiguity 
as to their nature. They are certainly bad for the com- 
munity, certainly bad for the other workers of the 
grade, almost certainly bad for the workers of the 
grade regarded as a whole. The higher wages must 
raise the money costs of production, and result, sooner 
or later, in fewer workpeople being employed in that 
occupation; larger numbers must accordingly seek 
employment elsewhere; and this cannot but depress 
the wage rates of less strongly organized trades. Thus 
the effect is twofold: a larger proportion of workpeople 
will be employed in badly paid occupations; and the 
wages there will be lessened. 

The power of a strong trade union to secure wage 
advances of this type is considerable, but it must not 
be exaggerated. Trade unions employ as a matter 
of course devices which, in the case of trusts, we regard 
as the extremest weapons of monopoly. To say, "If 
you buy from anyone except us, you must not buy at 
a lower price than ours," which Messrs. J. & P. Coats 
are represented as having done, is analogous to insisting 
that if non-unionists are employed, it shall be at the 
trade union rate, as every trade union very properly 



156 SUPPLY AND DEMAND 

iosists. To say, "You must buy only from us," the 
method of the boycott, as it is called, is analogous to 
the very common refusal to work with non-unionists 
at all. But in one important respect the tactical posi- 
tion of a trade union is weaker than that of an ordinary 
combination. It has usually got a buyers' combination 
up against it, in the shape of an association of employers. 
The latter will be governed in their attitude towards 
the workpeople's demands, not only by immediate 
expediency, but also by their own sense of "what should 
be"; and they will usually resist demands for wages 
greatly in excess of those obtaining in comparable 
trades. In this way, the tendency for workers of the 
same efficiency to receive the same real wages in all 
employments is far stronger than might at first sight 
appear. 

If we had to rely for this result upon trade unions 
alone, it would be highly problematical. For here a 
psychological curiosity emerges, which, famiUar and 
intelligible as it is, is none the less a curiosity. So 
far from still higher wages for well-paid workpeople 
being regarded in the world of manual labor as detri- 
mental to the interests of other workpeople, it has be- 
come almost a point of honor to believe the contrary. 
A wage dispute in a particular trade is conceived as 
an engagement in a far-flung battle between Capital 
and Labor, in which success at any part of the line 
will facilitate the victory of the whole army. This 
conception contains a measure of truth, as regards 
immediate and purely temporary effects; though, 
even here, it is made to seem unduly plausible by the 
recurrence of trade cycles, which cause wages at any 



LABOR 157 

time to move in the same direction all along the line. 
But, if the foregoing analysis has been appreciated, 
the essential falsity of this notion should be evident. 
It is an illusion, which should receive no endorsement, 
either tacit or express, in any work on economics. 
The general wage level of a country cannot be regarded 
(except temporarily, and within narrow limits) as a 
function of the efficiency of labor organization; it 
depends on the far deeper economic facts set out in 
§ 3 above. 

Let us now try to summarize the conclusions of this 
section. There is a tendency towards a uniformity 
of real wages for workers of the same grade and of the 
same efficiency. This tendency is not due to competi- 
tion alone. It is helped by many acts of a collective 
kind, arising from a sense of "what should be": it is 
obstructed by other acts of a like kind, where the sense 
of ''what should be" is based on imperfect under- 
standing. The more people act in accordance with 
''what should be," and the better their understanding, 
the more will this tendency approximate to an accurate 
economic law. 

§ 8. Women's Wages. The wages of women represent 
a problem of great public interest, upon which the 
principles laid down in this chapter have a most impor- 
tant bearing, and which in its turn serves to illustrate 
these principles further. It has been suggested that 
male and female labor can be regarded as a strong case 
of Joint Supply, and the suggestion is not merely face- 
tious. The essential point, that the proportions of 
available male and female labor are fairly constant (not 



158 SUPPLY AND DEMAND 

that they may not alter with time and circumstances, 
but that they are essentially independent of the condi- 
tions of demand) holds true not only of a country as a 
whole, but hardly less of a particular district. If men 
and women are to be regarded as separate grades, they 
are grades between which immobility is complete. 
Now men and women differ in many ways which affect 
both the demand for and the supply of their services. 
On the one hand, far fewer women wish to enter busi- 
ness employments of any kind, as women have plenty of 
work that must be done at home. On the other hand, 
though women can do many kinds of work as well as 
or better than men, it so happens that for much the 
greater number of services, which are in large demand 
in the business world, men are the more efficient. 
Incidentally, it happens that many occupations which 
women might do as well as men are closed to them by 
exclusive regulations. The resultant of these forces 
is that men and women are for the most part employed 
in different occupations, and the scale of payment 
in women's occupations is far lower than that in men's. 
Of this last fact singularly small complaint is made. 

It is otherwise, however, when we come to occupa- 
tions where men are either wholly or partially employed, 
where women are at least approximately as efficient 
as men, and where the barriers to their entry are at 
least formally removed. There a ferocious controversy 
rages over what is known as the principle of ^' equal 
pay for equal work." It is easy to understand why 
the male trade unionists in, let us say, the engineering 
trades, should support this claim. It is also, indeed, 
intelligible why the enthusiasts for Women's Rights 



LABOR 159 

should urge it; but it is much more doubtful whether 
they are wise. Possibly they are wise enough in their 
generation, since it might not serve them on this matter 
to get across the men. But it is clearly not prudential 
considerations of this kind by which they are mainly 
actuated. They make the demand, with extreme 
intensity of feeling, as a demand for fundamental 
justice. They are also very obviously inspired with the 
belief (similar to the illusion which is a point of honor 
with the male trade unionist) that high wages for 
women in well-paid occupations will help to raise the 
wages of sweated women workers in other trades. 

Now, here again, any lack of candor would be in- 
excusable. The effect of this policy on the wages in 
women's trades is certainly to reduce them. The pol- 
icy serves, as powerfully as any trade union custom, 
to restrict the entry of women into the men's employ- 
ments, and often spells virtual exclusion. For the 
*' equal efficiency" may be approximate only, and there 
may be advantages in male labor from the employer's 
standpoint which are none the less important, because 
they are not easy to define. Moreover, from the em- 
ployer's standpoint, the efficacy of female labor will 
be largely a matter for experiment, and ''equal pay" 
will give him no inducement to experiment at all. 
The diminished number of women in these occupations 
(as compared with what might have been) increases 
the number who must fall back on the purely women's 
trades; and it must serve to reduce the wages there, 
where organization is by no means strong. I am far 
from asserting that this consideration is conclusive 
against the principle of "equal pay for equal work" 



160 SUPPLY AND DEMAND 

(though I think it conclusive against a rigid interpreta- 
tion of it) ; for other matters, such as the standpoint of 
the male trade unionist must be taken into account. 
But the reactions on the wages in women's trades per- 
mit of no ambiguity. 

In occupations of another type, the issue takes a 
somewhat differeut form. In the teaching profession, 
''equal pay" would not exclude the women; it would 
be far more likely to exclude the men. For, though the 
advocates of the principle would declare that their 
intention is that the salaries of women should be leveled 
up to those of men, it is more probable that the ultimate 
outcome would be a leveling down. Educational 
authorities have the ratepayer and the taxpayer to 
consider; and, apart from this, they have their own 
interpretation of "what should be." To pay a woman 
less than a man for the same work may seem glaringly 
unfair; but it is not very clear why a woman, who is 
an elementary school teacher, should be paid much 
more than, say, a hospital nurse, merely because in the 
former case a number of men happen also to be em- 
ployed. In fact, there is a clashing of equities in this 
connection; and there is little doubt which of them 
the educational authorities would prefer. A leveling 
down of the men's salaries would make it all but im- 
possible to attract men of the desired type into the 
profession, and would thus lead to the virtual extinction 
of the male elementary school teacher. This might 
seem in a narrow sense to be economically desirable. 
Why should not men take their services to the tasks 
for which they can command a higher reward, and which 
women cannot do as well? But whether this would 



LABOR 161 

be desirable in the true interests of education is a far 
more doubtful matter. And this is the real problem 
of "equal pay for equal work" for male and female 
school teachers. The reader will notice that I have 
refrained from alluding to the controversy as to whether 
men should receive more on the grounds that they have 
wives and families to maintain. That, although a most 
absorbing issue, is not the real issue in practice at the 
present time. The real issue is a clashing between a 
sense of "what should be" on obvious general grounds 
and a sense of "what should be " in the particular, de- 
rived from the very patent and general "what is" that 
men receive as a rule far higher pay than women. 



CHAPTER X 

THE REAL COSTS OF PRODUCTION 

§ 1. Comparative Costs. Beneath the great diversity 
of the considerations which are apphcable to the dif- 
ferent agents of production, certain general conclu- 
sions emerge from the analysis of the last four chapters. 
In no case did we find that the aggregate supply of the 
agent was determined by clear and certain economic 
laws, possessing any fundamental significance. The 
supply of natural resources is a fixed thing, quite in- 
dependent of the efforts or the desires of man. How- 
ever the supply of capital and the supply of labor 
may react under present conditions towards economic 
stimuli, these reactions possess no quality of inevita- 
bility and bear no clear relation to 'Vhat should be." 
The supply of risk-bearing responds perhaps more 
decidedly to the prospects of increased reward; but 
it is so intimately associated with special knowledge 
and the qualities of business enterprise, as to leave 
some uncertainty attaching even to this conclusion. 
When, on the other hand, we turn to the apportion- 
ment of these factors among different uses, we find 
relations which are both clear and fundamental. Laws 
emerge which state at once not only ''what is" or at 
least "what tends to be," but also "what should be"; 
and it is the fact that they taste "what should be" 
that gives them their fundamental character. 

162 



THE REAL COSTS OF PRODUCTION 163 

These conclusions enable us to give a general answer 
to the question which was raised at the end of Chap- 
ter V: What are the ultimate real costs to which the 
money cost of production correspond? The attempt 
has often been made to relate money costs to such 
things as the effort of working and the sacrifice of wait- 
ing. The existence of such costs is beyond dispute. 
Much saving does mean a sacrifice of immediate enjoy- 
ment to the man who saves. Most labor is irksome and 
disagreeable in itself, and involves strain and wear and 
tear; while all labor means a deprivation of the utility 
of leisure. Workpeople, moreover, do not grow on 
gooseberry bushes, but must be fed and clothed from 
the cradle; and their rearing and maintenance repre- 
sents a real cost which someone must incur. 

But the existence (or the importance) of such costs 
is one thing, their relation to money costs is another. 
In Chapter VIII we saw how difficult it was to estabhsh 
any clear relation between the rate of interest and the 
sacrifice of saving. The costs of labor present similar 
difficulties. The relative irksomeness of two occupa- 
tions may affect the relative wages which will rule in the 
two cases; so, certainly, will the differences in the cost 
of education and training which they require. But 
these are matters which concern the apportionment 
of labor between different employments. There is 
no good reason to suppose that the general wage-level 
would be reduced, merely because work as a whole 
became less irksome, or involved a smaller physical or 
mental strain. The supply of people is not determined 
by the same kind of influences as is the supply of a 
conmiodity. Parents do not produce children for the 



164 SUPPLY AND DEMAND 

sake of the wages which the children will receive when 
they go out to work; or, if this happens, we rightly 
regard it as a horrible anomaly. In so far as parents 
are affected by economic conditions it is by their own 
economic conditions; the question is rather one of 
how many children they can afford to have, than of a 
balancing of the cost to them against the incomes 
which their children may subsequently acquire. But 
other considerations enter in; and, in fact, it is doubtful 
how the aggregate supply of labor will react to changes 
in prosperity. Finally, the supply of land involves 
neither effort nor sacrifice; and, among our money 
costs, we have to account for the item of the rent of land. 
To dispose of this difficulty by arguing that rent does 
not enter into marginal costs (in any sense which is not 
equally true of wages and profits) is to lose contact 
with reality. Thus the attempt to explain money 
costs in terms of the costs of producing the ultimate 
agents of production leads us into a quagmire of unreal- 
ity and dubious hypothesis. For a systematic theory, 
which will rest on firm foundations, we must interpret 
money costs in very different terms. 

The real costs which the price of a commodity meas- 
ures are not absolute, but comparative. Marginal 
money costs reduce themselves in the last analysis 
to the payments which must be made to secure the use 
of the requisite agents of productions. These payments 
tend to equal the payments which the same agents 
could have commanded in alternative employments. 
The payments which they could have commanded in 
alternative employments, tend in their turn to equal 
the derived marginal utilities of their services in those 



THE REAL COSTS OF PRODUCTION 165 

employments. It is thus the loss of Utility which 
arises from the fact that these agents of production 
are not available for alternative employments that is 
measured by the money costs of a commodity at the 
margin of production. 

This conception of ultimate costs encounters an 
instinctive repugnance, arising from a mistaken sense 
of logical symmetry, which it will be well to examine. 
Cost, it is objected, so interpreted loses its character 
as an independent entity. It is merely something de- 
rived from utility. Now in the earlier chapters of 
this volume, we found reason to be impressed with 
the general symmetry which pervades the relatioas 
of demand and supply. Moreover, when we considered 
the case of ordinary commodities we found that at 
the back of demand and giving rise to it was utility; 
at the back of supply, and limiting it, was cost. The 
general symmetry between demand and supply thus 
seemed ' almost to imply a fundamental symmetry 
between utility and cost. If, then, cost in the last 
analysis is derived from utility, does not this make 
nonsense of the symmetry between demand and supply, 
or, if we cling to this last symmetry as a demonstrable 
truth, must we not refuse to admit that cost can be 
derived from utility? 

This is one of those false dilemmas which supply the 
wiseacres of the world with a plausible case for dis- 
trusting the logical faculty. If we have good reason for 
believing that both of two apparently inconsistent 
things are true, the explanation is seldom that one of 
them is really false; it is more usually that they are 
not really inconsistent. So it is here. The symmetry 



166 SUPPLY AND DEMAND 

between demand and supply is very great, and we 
should always look to see if it holds good, but it is by no 
means perfect, and it is in the last analysis that it most 
notably fails. It is most important to distinguish 
clearly between the utility and the cost of a com- 
modity as two separate and independent things. Iq 
Chapter V, it will be remembered, we did not permit 
ourselves to derive the costs of producing cotton lint 
from the utility of cotton-seed. The refusal to do so was 
essential to clear thought; it led to some very useful 
practical corollaries. But to derive the cost of a com- 
modity from the utility of something which is produced 
with it, as part of the same productive process; and to 
derive the cost from the utilities which the agents, 
which help to produce it, possess for other purposes, are 
two entirely different things. In works on International 
Trade, the reader will discover that the comparative 
nature of real costs is so unmistakable that a Doctrine 
of Comparative Costs is expounded with much formal- 
ity at the outset. This doctrine is apt to prove some- 
what puzzling, when we have to deal with it as an appar- 
ent exception to the general tenor of economic theory. 
Its difficulties disappear when we realize clearly that 
the real cost of anything is the curtailment of the supply 
of other useful things, which the production of that 
particular thing entails. 

§ 2. The Allocation of Resources. However strange the 
above conception may seem, there should be no doubt 
that this cost is very "real." Here the irregularities and 
maladjustments of the economic world, the recurrence 
of trade depressions and the like, do much to obscure 



THE REAL COSTS OF PRODUCTION 167 

a clear vision of the essential realities. At a time when 
there is much unemployment, and much machinery 
standing idle, it is so clear to common sense that we 
could produce more of some particular thing without 
diminishing the supply of other things, that any ap- 
parent statement to the contrary may perhaps seem 
the height of academic pedantry. But let me ask the 
reader to consider with an open mind a familiar parallel. 
During the recent war there was inevitably much waste 
and muddle in the utilization of the military resources 
of the Allies. Some regiments would be kept inactive 
for long periods, not for purposes of rest or training, 
but owing to some defect of organization. In the 
manufacture of munitions, an insufficient appreciation 
of the principles of joint demand led to the piling up of 
excessive stores of certain materials, which were useless 
until commensurate supplies of the complementary 
factors could be obtained. It is unnecessary to multiply 
examples. The waste of both man-power and material 
was immense. But the allocation of these resources 
between, for instance, the various theaters of war was 
none the less a very real problem, which gave rise to 
much engrossing controversy. It was an axiom that 
the more resources you employed in Mesopotamia or in 
Palestine, the less resources remained available for 
France. No one thought of maintaining that, as long 
as there was any waste of these resources, so long as 
there remained any men to be "combed out" of un- 
essential industries, you could pour troops and muni- 
tions into Salonika without stopping to consider the 
needs of other theaters of war. Such a notion would 
have been clearly imbecile, for the sufficient reason 



168 SUPPLY AND DEMAND 

that the sending of armies to Salonika would do nothing 
in itself to secure (however much it might incidentally 
stimulate) the more efficient use of the resources which 
remained. 

Now this is precisely analogous to the problem of 
the allocation of our resources for the purpose of peace. 
Notwithstanding all the wastes and maladjustments 
of the economic system, the use of resources to produce 
one commodity does in general curtail the production 
of others. The mere launching of a new business enter- 
prise does no more than the sending of an army to 
Salonika, to eliminate waste in the remainder of the 
economic organism. Unemployment, broadly speaking, 
is a function not of the magnitude of the normal demand 
for labor (which affects rather the wage-level), but of 
fluctuations in the demand for labor; fluctuations 
from one day to another as at the docks, from one 
season to another as in the building trades, above all 
from one period of years to another as in the cycles of 
general trade boom and depression. Nothing will 
diminish unemployment which does not serve to 
diminish these fluctuations. A new business will not, 
as a rule, have any such effect. If it is launched dur- 
ing a trade depression (a most unusual proceeding), 
it may temporarily absorb unemployed labor and idle 
materials. But when the next boom comes, it wiK 
be using, though presumably i<i greater advantage, 
labor and materials which, but for it, would have 
been employed for other purposes. Meanwhile the 
causes making for unemployment will be unaffected. 
Miscalculations will still be made, the building trades 
will still become slack in the winter, the casual methods 



THE REAL COSTS OF PRODUCTION 169 

of engaging dock laborers will still continue, trade cycles 
will still recur, while beneath them, and concealed by 
them, some industries will expand and others will decay. 
Thus, like the armies at Salonika, the new business 
would in effect divert resources from elsewhere. 

This truth needs to be firmly grasped in mind. It 
is this that makes it in general unsound policy to sub- 
sidize industries, either directly or indirectly, by means 
of a protective tariff. It is this, indeed, that supplies 
the answer to half the economic fallacies that are al- 
ways current. 

The allocation of resources so as to yield the maxi- 
mum effect was rightly recognized as one of the most 
vital and difficult of our war-time problems. To cope 
with it, the Allied peoples devised one instrument after 
another, and finally evolved the Supreme Allied Couq- 
cil. The analogous problem in the economic world of 
peace time is no less important and far more difficult; 
but there is nothing to correspond to the Supreme Al- 
lied Council. There we rely upon a co-operation which, 
as was stressed in Chapter I, is unco-ordinated. That 
co-operation has been evolved by the mutual com- 
petition of innumerable business concerns, controlled by 
men largely animated by the motive of pecimiary profit. 
But it has not been evolved wholly by such means: 
and how far that competition or that motive of profit 
is essential to its efficiency are questions with which 
this volume has not been in any way concerned. The 
economic laws, the relations between utility, and price 
and cost, with which it has been occupied, are an en- 
tirely different matter; and these are essential to the 
efficiency of any system of society. For if the marginal 



170 SUPPLY AND DEMAND 

utility of a commodity is equal to its marginal cost, and 
if this marginal cost is composed of payments to the 
various agents of production at least as great as they 
could have obtained if they had been used otherwise, 
this amounts to saying that the agents of productioQ 
are so utilized as to yield the maximum utility; and 
this is the same thing as saying that they are so utilized 
as to produce the maximum wealth. 

§ 3. Utility and Wealth. Upon this last point it is 
important to be quite clear. An increase in wealth 
seems a solid, tangible reality; something, which, 
however much we may scorn it in our more precious 
moods, we recognize, for a rather poor community, 
to be an important object of endeavor. But an in- 
crease in utility seems a vague, impalpable notion, 
hardly deserving the same practical concern. None the 
less the two things are identical. We greatly deceive 
ourselves if we suppose wealth to be an objective reality. 
It is true that, when we get behind the money in which 
it is measured, we come upon commodities, like food 
and clothes and houses and factories, which seem 
comfortably solid and objective things; but we also 
come upon many services, like those of gardeners and 
doctors and hospital nurses, which we are bound to 
reckon as part of our wealth, although they are not 
embodied in any tangible commodities. Moreover, 
although material commodities are objective realities 
in themselves, and in many of their properties, they are 
not objective realities in their property as wealth. A 
pair of boots is an objective fact; so is the number of 
pairs in existence at any time, so is their size, theu* 



THE REAL COSTS OF PRODUCTION 171 

weight, the quantity of leather or of paper which they 
happen to contain. But the wealth which those boots 
represent is not an objective fact. It depends upon the 
opinion which men and women entertain as to their 
utility; and these opinions take us into the subjec- 
tive regions of human psychology. Let us suppose, 
for instance, that we calculated, on the basis of present 
prices, that the boots in existence at the present time 
represented roVo P^^ ^^ ^^^ total wealth. Suppose, 
then, that a miracle were to happen; that the skies* 
opened and rained boots upon us, of every size and 
shape and pattern, until we had 1000 times as many 
boots as we had before. Could we say that our total 
real wealth had been doubled? Clearly we could 
not. To obtain boots for nothing, and to wear a new 
pair every week, would make us somewhat better off,, 
but not twice as well off as we were previously. In. 
other words, the real wealth of a thousand times as; 
many boots as we have now, is not a thousand times as 
great as the wealth of the present number of boots. We 
are, indeed, practically restating the Law of Diminish- 
ing Utility; and this perhaps is enough to show that 
wealth is fundamentally the same thing as utility. 

Another point, however, is worth noting. Our real 
wealth would be somewhat increased in the case sup- 
posed; but if we were to turn to the money measure 
of wealth, the opposite result would be far more likely, 
For the price of boots would most likely fall to nothing, 
and the total value of boots, in the commercial sense, 
would accordingly be nothing also. This shows that 
money values may be a most imperfect measure of 
aggregate wealth; for what money values represent is 



172 SUPPLY AND DEMAND 

the product of the quantity of the commodity and its 
marginal utility, while aggregate wealth is total utility, 
which is a very diiferent thing. This, it may be ob- 
served, makes all attempts to compare the wealth of dif- 
ferent countries or different times, and no less to con- 
struct Index Numbers of Prices, imperfect of necessity, 
and arbitrary in their foundations. 

§ 4. Criteria of Policy. The point has now been reached 
at which we must take into accoimt the very important 
fact which was mentioned at the close of Chapter III. 
The maximum utility which the laws of supply and 
demand tend to bring about is a maximum total utility 
indeed, but one still measured in terms of money. An 
unequal distribution of wealth destroys any necessary 
correspondence between that and the maximum real 
utility. This consideration, however, does not affect 
the general validity of the conclusion that the laws of 
supply and demand represent what is socially desirable 
now or under any system. For what is at fault here is 
the distribution of wealth; and it is that which should 
be changed, in so far as it is possible to do so. Now it is 
important to realize that whenever it is possible to 
supply a commodity to poor people below cost price, 
it is possible to alter the distribution of wealth, for that 
in effect is what is done. Purchasing power, which may 
be taken from richer people by taxation, or which may 
be obtained from ''collective" profits on other trading, 
is in effect transferred to the poor people in question, 
though the transference is coupled with the condition 
that the purchasing power must be expended in a 
particular way. It is in general desirable that the 



THE REAL COSTS OF PRODUCTION 173 

transference should be made without this condition 
being attached. To this general statement, exceptions 
indeed exist so numerous and important as possibly to 
justify a great extension of social expenditure of this 
type. Education should certainly be provided free of 
charge, there are strong arguments for subsidizing 
housing; the provision of milk to expectant mothers, 
the feeding of school children, such instances can be 
multiplied into a very extensive list. But it is impor- 
tant to observ'e that in each case the justification of the 
policy rests in the presumption that the service supplied 
is one which it is particularly important that the bene- 
ficiaries should have, as compared with the other things 
upon which they might have preferred to expend the 
equivalent purchasing power, had it been transferred 
to them without conditions. Where there is no such 
presumption, as surely there is none in the case of the 
great bulk of commodities, the relation between price 
and marginal cost should be rigidly maintained; it 
is the distribution of purchasing power which we should 
rather seek to alter. How far is it possible to alter that? 
I suppose that it is inevitable that many readers will 
have concluded that the preceding chapters must be 
taken to mean that the distribution of wealth is not 
susceptible of any appreciable change. I would remind 
those readers of an important distinction upon which 
impatient people have sometimes based a complaint 
against economists. The economist, it is said, analyses 
with great pomp and ceremony the laws governing the 
distribution of wealth among the agents of production, 
but says practically nothing about the distribution 
between individuals and classes, which is the only thing 



174 SUPPLY AND DEMAND 

of any real interest to practical people. Now the econ- 
omist concentrates on the agents of production for 
the very good reason that it is only with respect to them 
that any clear and certain laws as to distribution can 
be laid down. Into the distribution between indi- 
viduals and classes there enter other and variable 
factors, governed by no fundamental economic law; 
and here, the conclusion should at once suggest itself, 
is the field for action designed to alter the distribution 
of wealth. What is possible or desirable in this field, 
it is again not the purpose of this volume to discuss. 
It is an obvious, even if not a very helpful conclusion 
that an increase in the habit of saving among weekly 
wage-earners might, without appreciably affecting the 
distribution between Capital and Labor, greatly mod- 
ify the resulting distribution between social classes. 
But questions as to how far it might be possible or 
justifiable to achieve a similar result by the use of the 
weapon of taxation, by changes in inheritance laws, or 
by the public ownership of industry take us into a far 
more uncertain and controversial sphere. The difii- 
culties and objections which present themselves are 
familiar and formidable; but they are of quite a dif- 
ferent order from the economic laws which we have 
been examining. The laws themselves do not entitle us 
to make any dogmatic pronouncement upon these large 
issues of social policy. 

But this is not to deprive these laws of practical 
importance. They represent essential criteria of sound 
policy in the sphere of social reorganization no less than 
in ordinary business. In our days a curious obsessioa 
lias led many people to disparage these criteria, as 



THE REAL COSTS OF PRODUCTION 175 

though they were the sordid prejudices of a stupid 
tradesman. Because it has been found a matter of 
obvious practical convenience to maintain the roads 
out of taxation or of rates, and to dispense with charges 
for their use, it is suggested that the same principle 
should be applied to the railways. Or, more commonly, 
because it has been found convenient to make the same 
charge for the carrying of letters between Land's End 
and John o' Groats as between Hampstead and High- 
gate, it is suggested that this principle should be applied 
to railway rates and fares. It may be well, therefore, to 
point out that the justification of uniform postal charges 
rests upon the facts: (1) that the costs of collection, 
sorting, etc., are so large a part of the costs of carry- 
ing a letter, that the real cost between Johu o' Groats 
and Land's End does not differ from that between 
Hampstead and Highgate by as much as might at 
first sight appear, (2) that the charges in any case are 
very small; so that (3) the avoidance of the small de- 
gree of taxes and bounties which the present system 
implies is not worth the book-keeping expenses which 
differential charges would involve. It should be ob- 
vious that these considerations apply to the railways 
with a greatly diminished force. They might possibly 
justify what is known as the "zone" system of charges, 
i. e. uniform rates within certain narrow areas. But the 
notion of uniform rates throughout Great Britain 
conjures up a vision of trains taking coal from South 
Wales to Scotland, and others taking coal from Scot- 
land to South Wales, in accordance with the slightest 
preferences of the consumers, and without regard to the 
extra real cost involved, on a scale to which the "wastes 



176 SUPPLY AND DEMAND 

of competition" afford no parallel. It would in fact 
achieve the essential folly of ''sending coals to New- 
castle." These considerations, however, are not what 
interest the advocates of the postal principle. They seem 
to recommend the obliteration or the confusion of the re- 
lations between price and cost as a superior ideal. It is 
important to be clear what exactly this ideal involves. 

It involves, in the jBrst place, as the whole argument 
of this volume has gone to show, a less economical 
employment of our productive resources; they would 
be diverted to ends of less utility, and so produce less 
real wealth. But this is not the worst. There is plenty 
of waste and maladjustment in our economic system at 
the present time. The desirable relation of price to 
marginal cost is but imperfectly attained. The further 
departures from this relation, which would follow from 
any likely applications of the postal principle, might not 
matter in themselves so very much. What is far more 
serious is that the criteria of efficiency would become 
blunted, and the clear aims of management would be 
confused in fog. It is essential that every manager 
should be on the alert to eliminate waste and to improve 
efficiency, that he should be always trying to secure 
the best results; but how can he do this if he has no 
simple means of measuring what results are good and 
what are bad? The measure which he has at present 
is that of price, cost and the resultant profit, and it 
would be fatal to take that away, unless an equally 
simple and more accurate measure could be substituted 
for it. 

This is not a question, it should be observed, of 
motive or incentive. Very likely we much exaggerate 



THE REAL COSTS OF PRODUCTION 177 

the importance of the profit motive. It may be true 
that men would work, perhaps that they already work 
in fact, as zealously for a fixed salary, as for personal 
gain. But aim and motive are two somewhat different 
things, and the aim of profit, is, and will remain, essential 
to the efficient conduct of business. In a game the 
players are not animated by the motive of scoring runs 
or points, but they aim at them; and the zest disap- 
pears very speedily from the game, if that aim ceases 
to be of interest. Moreover, while a scoring system is 
always a somewhat arbitrary thing, measuring im- 
perfectly the true merits of the play, if it measures 
them with the roughest accuracy, we prefer the issue 
of our games to be decided so, rather than by the de- 
cisions of an impartial judge, who can take into ac- 
count the finest points of skill. So it is in the world 
of business. The scoring-board of profits may be an 
imperfect one; let us, by all means, where we can, al- 
ter the rules of the game so as to make it better. But 
let us not imagine that it displays a finer insight or a 
superior intellect to speak as though the scoring-board 
could be dispensed with, and the test of profit and loss 
treated as irrelevant. Quantitative measurement is 
essential to efficiency. Let us be careful to remember 
all that this implies. 



INDEX 



Ability, 152 
Accountancy, 58 
Allocation of resources, 166 
Ambiguities, 24 
Australasia, 66 

Bastiat, Frederic, 5 

Beef and hides, 7 

Borrowing and lending, system 

of, 12 
Business efficiency, 58 
Business man as a purchaser, 47 
Business risk, 104 

Capital, 119; as representing a 
perioQ of waiting, 123; dis- 
tribution, 131; distribution 
and rate of interest, 137; ef- 
fect on labor of an increased 
supply, 77; not a stock of 
consumable goods, 123; re- 
action of price charges on, 31 ; 
reflections upon, 11; supply, 
130; supply as affected by 
charges in interest rate, 132 

Capital goods, 61 

Capital market, 13 

Capitalism, 17 

Capitalist, 116 

Chance, 105 

Coal industry, cost of produc- 
tion and price, 52; miners' 
wages, 75 

Coats, J. & P., 75, 155 

Collective saving, 129 

Commodities, 7, 19; labor as a 
commodity, 19 

Competition, 140 

Composite demand, 80 

Composite supply, 80 

Consumable goods, 123 



Consumers' goods and pro- 
ducers' goods, 49 

Consumption, margin of, 37; 
waiting for, 121 

Control and risk-taking, 116 

Controversy, 1, 6 

Cooperation, 3; unorganized. 

Cost, general relation of price, 
utility and cost, 65; price 
relation to, 37, 39, 52; rent 
as factor in real costs, 100; 
ultimate, 82, 162; utility and, 
165 

Cotton and cotton-seed, 7; 
contrast to wool and mutton, 
71 

Cotton industry, 154 

Criteria of policy, 172 

Currency inflation, 33 

Cycles, 34, 125 

Demand, ambiguity of expres- 
sion "increase in demand," 
24; derived, 82; elastic and 
inelastic, 76; see also Com- 
posite demand; Joint de- 
mand; Supply and demand 

Derived demand, 82 

Derived utility, 49 

Diagrams, use of, 21 

Diminishing utility, 40; money 
and, 49 

Directors, 135 

Distribution of wealth, 131, 
172; interest rate and, 137 

Dividends, 135 

Division of labor, 3 

Economic laws, 140, 142; fun- 
damental character, 17 



178 



INDEX 



179 



Economic theory, v, 143; fact 
and, 1 

Economic world, orderly na- 
ture, 1 

Education, 150, 160 

Efficiency, 58, 177 

Elastic demand, 76 

Employers' associations, 156 

Enterprise, 104, 109 

Entrepreneur, 113 

"Equal pay for equal work," 
158 

Expectation, 106 

Fact and theory, 1 
Farmers, 90 
Fortunes, 116 

Gambling, 106 

Government, enterprises, 114; 
failings, 139 

Hides and beef, 7 

Houses, 103 

Housewife as purchaser, 41, 43, 

44 47 
Housing, 64, 129 
Ideas and institutions, 141 
Incompetents, 59 

Increase in demand, ambiguity, 
24 

Index numbers, 172 

Inelastic demand, 76 

InjQation, 63 

Institutions and ideas, 141 

Insurance companies, 107, 111; 
significance, 108 

Interest, 119; necessity of, 129 

Interest rate, 14; changes and 
their effect on supply of 
capital, 132; distribution and, 
137; price of land and, 102 

Intuition, 114 

Joint demand, 66; importance 
of the unimportant, 74; mar- 
ginal utility under, 69; sum- 
mary of considerations, 79 



Joint products, 7; cost of pro- 
duction, 40 
Joint-stock company, 135 
Joint supply, marginal cost 
under, 66; summary of con- 
siderations, 79 

Keynes, J. M., vi 

Labor, 139; apportionment 
among occupations, 153; ap- 
portionment among places, 
147; apportionment among 
social grades, 149; as a com- 
modity, 19; cost, difficulty of 
estimating, 163; division, 3; 
effect of increased supply of 
capital, 77; four grades, 149; 
mobility, 148; product of, 
119; reaction of price changes 
on, 31; supply in general, 
145 
Laissez-faire, 11; retrospect on, 

139 
Land, characteristics, 83; dif- 
ferential aspect, 87; margin 
of transference, 94, 96; mar- 
ginal, 88; price and rent, re- 
lation, 102; question of real 
costs, 100; scarcity aspect, 
84; supply, 30; tenure, 92; 
urban, 94; see also Rent 
Landlords, 91, 92 
Large scale business, 58 
Laws, fundamental, 18, 29 

Malthus, T. R., 146 
Management, 104 
Margin, danger of ignoring, 57 
Margin of consumption, 37 
Margin of production, 52 
Margin of transference, 94, 96 
Marginal cost, aspects, 55; mis- 
interpretation, 59; under 
joint supply, 66 
Marginal land, 88 
Marginal purchaser 44 



180 



INDEX 



Marginal utility, 42; price re- 
lation to, 43; under joint de- 
mand, 69 

Market, 13 

Marshall, Alfred, vi 

Marx, Karl, 119 

Mill, J. S., 86 

Miners, 75 

Monetary changes, disturb- 
ances of, 33 

Money, diminishing utility, 49 

Monte Carlo, 106 

Mutton. See Wool and Mutton 

Natural ability, 152 
Normal conditions, 36 

Occupations, 150; apportion- 
ment of labor among, 153 
Order, economic, 5 

Pasture versus tillage, 97 

Pigou, A. C, vi 

Policy, criteria, 172 

Population, 85, 146 

Postal charges, 175 

Poverty, 131; national, 128, 
129 

Price, consequences of higher, 
60; general relation with 
utility and cost, 65; law of 
tendency, 19; marginal util- 
ity and, 43; post-war, 61; re- 
action of changes in demand 
and supply, 27; relation of 
demand and supply to, 20; 
utility and, 40 

Producers' goods, 49 

Production, power of, 125; real 
costs, 162; waiting for, 120 

Professions, 150 

Profiteering, 75 

Profits, 61, 177; elements, 104; 
general analysis, 117; in 
risky industries, 110, 115 

Protective tariff, 169 

Psychology and economics, 1 



Purchasers, business man, 47; 

housewife, 41, 43, 44, 47; 

marginal, 44 
Purchasing power, 33, 61, 172 

Railway rates, 175 

Railways, 64 

Rate of interest. See Interest 
rate 

Rent, 82, 83; complex char- 
acter, 90; marginal land, 89; 
necessity, 98; rate of interest 
and, 102 

Reserves, 136 

Residuary profits, 110 

Resources, allocation, 166 

Risk, reward for, 104; under 
large-scale organization. 111 

Satisfaction, 50 

Saving, 127, 174; individual, 
127; involuntary, 134; psy- 
chology, 133; social, 128 

School teachers, 160 

Service, 19 

Serving cotton, 74 

Shareholders, 135 

Sinking-fund, 134 

Situation, 88 

Smith, Adam, v, 139 

Social grades, labor movement 
among, 149 

Socialism, 9, 11, 14, 59, 134, 141 

Speculation, 112-113 

Steel smelters, 76 

Subsidies, industrial, 169 

Substitutes, 80 

Supply, reactions of price 
changes on, 30; see also Com- 
posite supply; Joint supply 

Supply and demand, changes 
in, and their reaction on 
price, 27; forces behind, 37; 
general laws, 18, 29; relation 
of price to, 20; wages and, 
143 

Supreme Allied Council, 169 



INDEX 



181 



Teachers, 160 
Theory, economic, v, 1 
Thrift, 127 

Tillage versus pasture, 97 
Trade cycles, 34, 125 
Trade depression, 33 
Trade unions, 144; actions, 154; 
wage level and, 156 



Ultimate real costs, 82, 162 
Unearned increment, 86 
Unemployment, 168 ; trade 

union policy and, 144 
Utility, 37; cost and, 165; de- 
rived, 49.; general relation of 
price, utility and cost, 65; 
law of diminishing utility, 
40; law of diminishing utility 
as applied to money, 49; 



marginal, 42; price relation 
to, 38, 40; wealth and, 170 

Wages, general wage level, 143; 
trade unions and, 155, 156; 
women's, 157 

Wages Fund, 125 

Waiting, essence of, 126; for 
consumption, 121; for pro- 
duction, 120 

Waste, economic, 167, 168, 176 

Wealth, distribution, 131, 137, 
172; utility and, 170 

"What should be" and "What 
is," 141 

Women's wages, 157 

Wool and mutton, 7, 66; con- 
trast to cotton and cotton- 
seed, 71 

Workers' control, 117 



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